What Is Homeowners Insurance And How Does It Work?

With all you have tied up in your home — most of your possessions, your family’s future, not to mention the massive financial commitment — it’s essential that you have sufficient house insurance to hedge against a big or even total loss of property at your home. In fact, most lenders will require that you have at least some level of homeowners insurance before they’ll back your mortgage.

Let’s look more in-depth at homeowners insurance and how it provides crucial financial security and peace of mind.

Standard homeowners insurance typically offers a range of protections for your property and personal belongings. It covers damage to your home’s structure and personal belongings in the event of perils such as fire, storm damage or theft. It also provides liability if someone is injured on your property, medical payments to cover injuries, and additional living expense coverage if you need to move out during repairs.

Homeowners insurance covers your personal belongings within your home, including furniture, clothing, jewelry and other possessions, plus key appliances and mechanical systems like your furnace and air conditioner. Some insurance companies ask you to provide descriptions and photos of high-priced items like artwork or jewelry that can be referenced if you make a claim.

Most standard policies also provide coverage for garages, sheds, outdoor grills, swing sets, fences and more. High-risk items like swimming pools may require additional coverage.

As a homeowner, it’s important to understand the details of your policy and how much coverage you can expect when you file a claim. For instance, most policies do not cover damage caused by floods or earthquakes. For these you’ll need to pay for additional insurance.

Are You Required To Have Homeowners Insurance?

Homeowners insurance isn’t required by law, but it is often required by lenders as a condition of mortgage approval. This helps protect the financial interest that your mortgage lender has in your home.

But the question “Is homeowners insurance required?” has both a legal and a practical answer. Practically, home insurance should be a requirement of your own financial strategy. It can help you protect yourself from enormous financial loss. It can also help cover the cost of paying for bodily injury to others. If your dog bites a passing jogger, for example, you might be sued and have to pay a claim of several thousand dollars. Homeowners insurance covers these unexpected events.

Like any other type of insurance, homeowners insurance doesn’t do anything until a tree falls on your garage and you need it. As you’re about to buy a home, you’ll get quotes from a few insurers based on how much coverage you’d like and how much you’re on the hook for (your deductible) before the insurance pays the rest. Let’s examine how you can choose coverage and deductible amounts wisely, as well as how you file a claim and what happens when you do.

1.Choose The Amount Of Coverage

For this step, it’s advisable that you work with an insurance broker, preferably a respected one from your community. They will help you select the best coverage, based on the characteristics of your home, while ensuring that you don’t pay too much for coverages you don’t need.

Your homeowners insurance should provide meaningful coverage over four broad categories, and each should be considered individually:

Dwelling

This coverage most broadly covers the cost of replacing your entire house, including outbuildings and other structures, in the event of a catastrophic, total loss, such as a fire. This is known as the “replacement cost.” This is not the same as what you paid for the house, but should reflect what it would cost to rebuild your home, in your neighborhood, with current construction costs.

Property

Personal property coverage entails basically all of your possessions you keep at home that can be lost or damaged due to theft, fire or other calamity. Since it’s hard to put a value on everything you own, most insurance companies set a personal property coverage limit as a percentage of the dwelling coverage, usually 50% or 70%. If you have very expensive possessions, such as artwork or jewelry, that would not be replaceable under such coverage, you should take out extra insurance to cover those.

Personal Liability

Most homeowners insurance policies provide protection in case somebody is injured on your property, or their property is damaged. For example, if a guest falls on your property and breaks their arm, you could be found liable and have to pay for their medical expenses.

Personal liability coverage is usually at least $100,000 and often up to $500,000, sometimes more if you want to buy more coverage. If you have a lot of net worth, it’s best to buy more coverage. To wit, all of your assets are exposed in the case of a lawsuit from one of those “Slip and Fall” attorneys you see on billboards around town. They thrive on personal liability claims.

Additional Living Expenses

If your house is destroyed or rendered unlivable by a fire or natural disaster, this coverage is there to pay for a temporary place to live, such as a hotel or rental property, while your home is being rebuilt. It would also cover the additional cost of food due to your no longer having a kitchen.

Additional living expenses (ALE) coverage is usually stated as a percentage of your extended dwelling coverage, typically in the 20% – 30% range.

2.File A Claim

There are actually two parts to the process of filing a claim on your homeowners insurance — before and after. Here are two steps you can ahead of a claim take to make the claim more effective:

• Take inventory of your home: Make a thorough record of everything in your house that has value, such as furniture, appliances, clothing, artwork and jewelry. Take photos and write up descriptions of each item, with an assessed dollar value. If you have receipts, include those.
• Know your deductible. There’s no point in even filing a claim if the cost of repairs is less than your deductible amount.

If you do decide to make a claim, here are the next steps:

• Make a list of all your damaged property. You’ll need this when you meet with your adjuster.
• Take photos and videos of the damage.
• Contact your insurance company or agent with your policy number, name, address, and phone number.  
• Meet with the adjuster, who will inspect the damages, make an assessment of the repair/replacement costs, and write you a check.

3.Pay A Deductible

A homeowners insurance deductible is the amount of money a homeowner must pay out of pocket before home insurance coverage kicks in. When the insurance company pays the claim, it will be for the total amount of the damage minus the amount of the deductible.

You won’t pay your deductible to the insurance company like a bill. Instead, it’s subtracted from the amount the insurance company pays. Most deductibles are between $500 and $2,000. The higher the deductible, the lower your monthly premium since it’s less risk for the insurance company. Also, know that the deductible is applied to each claim, and not just on an annual basis.

Homeowners insurance is designed to first and foremost protect you from a catastrophic loss of your entire house. It’s also there to protect most of your possessions. This insurance typically protects against the following perils:

• Personal property coverage: Personal property includes the items in your home, such as furniture, electronics and other personal possessions. Homeowners insurance will replace your personal property if stolen or damaged in a covered loss.
• Liability coverage: Liability coverage protects you from a financial settlement if someone sues you after suffering an injury on your property or you cause an accident to someone else on your property.
• Fire: Homeowners insurance can cover fires that occur on accident, such as electrical fires and grease and candle fires. House fires are common, which is why standard policies cover them. Your homeowners insurance will cover the cost of rebuilding your home and usually your living expenses, such as hotel bills, while your home gets rebuilt.
• Natural disasters: As part of your dwelling coverage, homeowners insurance covers natural disasters such as windstorms, hail, lightning strikes and wildfires. However, you must purchase a separate policy for floods or earthquakes because homeowners insurance doesn’t cover these acts of nature.
• Theft or vandalism: Aside from covering the cost of stolen items, homeowners insurance covers vandalism, riots and civil unrest. For example, if someone breaks into your home, your insurance may pay to replace your doors and windows to make it safe again. Insurance may cover other elements of your home, depending on the circumstances.
• Additional living expenses: Many homeowners insurance policies will also cover additional living expenses you incur while your home or property is being repaired. These can include hotels, rentals, food and more.

This is just as important to ask as what it does cover. Many people are shocked, and can even be financially ruined, when they find that a catastrophic loss to their home is not covered by their policy.

Say you’ve finished your basement and built a man cave with a pool table, game room and a custom bar. If a storm sewer was to back up and flood everything, that loss will likely not be covered by an ordinary policy. You can get additional coverage written in, but you’ll have to pay extra.

• Flooding: You must get separate flood insurance to cover water damage caused by a river running over its banks, rainstorms, melting snow or other natural causes.
• Water damage: Water damage may include sump pump or sewer backup water damage, but homeowners insurance typically doesn’t cover it. You must obtain additional coverage or select add-on policies to cover this type of water damage. However, property damage from malfunctioning sprinkler systems or water pipes that burst is usually covered.
• Earthquakes: Most standard homeowners insurance policies don’t cover earthquake damage. You’ll pay out of pocket for repairs if you don’t have separate earthquake insurance.
• Failure to maintain property: If you fail to maintain your property or don’t take care of it, homeowners insurance may not cover certain damage. If a person falls because of a broken porch step, for example, your liability may not be covered because you did not repair the step.

The cost of homeowners insurance varies a bit, even from house to house in the same neighborhood. This is because the formula insurance companies use is dependent on several factors that can push your premium higher or lower. Studies show that a typical policy on a dwelling with $300,000 of coverage costs in the range of $100 - $130 per month. Here are some of the key factors that will weigh on how much the policy will cost for your particular house:

• Geographic location: Your rates could be higher if you live in a place where natural disasters, such as floods, wildfires, hurricanes or tornadoes are more likely. Other geographic concerns that can drive higher rates include high crime, construction costs in the area, and fire response. For instance, is the local fire team professional or volunteer, and are they nearby or miles away?
• Age and condition of the home: Insurance companies view homes of 40+ years to be higher risk to insure. Older wiring may lead to a fire, and older plumbing can burst. In general, modern building codes can be stricter than in the past, which means replacing materials and systems is more expensive.
• House features: Older homes can be built with materials that, if available, are now very expensive, such as a slate roof. Some were built with craftsmanship that, if available, is very expensive to replicate. It’s rare to find a worker who can replace a coved plaster ceiling, for example.
• Deductible: Pretty simple. The lower the deductible you pay out of pocket for a claim, the higher your monthly premium.
• Endorsements: You may have a few possessions that are extremely valuable, such as artwork or jewelry, which cannot be covered by your blanket policy. You may wish to buy add-ons to your policy that cover these expensive items individually.
• Credit score: Your credit score reflects your overall ability to pay your monthly premiums and keep up with house repairs and maintenance. A good credit score keeps premiums lower.
• Claims history: Frequent claims on the property, even from previous owners, indicate a risk of future claims and can drive up the premium.

Since your policy is highly dependent on the property you’re buying, the right time to seek a policy is when you’ve identified the house. Your realtor should have excellent knowledge of insurance issues common to the area, as well as the names of reputable local insurance brokers.

1. Determine The Amount Of Coverage You Need

The home’s location, condition and particularities will dictate how much coverage you need. In most cases, a general policy should provide adequate coverage for pretty much everything. Coverage is broad and covers four basic categories—the dwelling itself, personal possessions, personal liability and additional living expenses—as discussed in more detail above. But if there are particular risks to the property not covered by a standard policy, you’ll need to consider extra coverage.

2. Compare Quotes From Different Insurance Companies

Look at insurance coverage options from a variety of companies so you make sure you get the best rate for you. Insurance is a competitive industry, so rates don’t vary too much. You might find an offer for a low introductory rate that reverts back to the mean after a year.

Compare the different types of coverage against the costs — even within the same company. Check out the reviews of each insurance company to learn more about customer service. You can buy insurance online, but many people prefer to have a personal connection with the local insurance broker in town.

3. Choose A Policy

Choosing a homeowners insurance policy is the last step in what should have been a careful assessment of your particular property, preferably face-to-face with an insurance broker. Be sure that any valuable possessions get extra coverage.

Also, most experts suggest that you get “replacement value” coverage on your dwelling, as opposed to a “cash value” policy. It will cost a little more, but replacement value covers the cost of a new version of your home and possessions, while a cash value policy considers the age and depreciation of your property.

Here are the answers to some of the most frequently asked questions about homeowners insurance.

What is the point of having homeowners insurance?

If you own your home, you likely have a massive financial stake in it. It’s not uncommon for your house to be worth more than several times your annual income. If you were to lose it to a fire or other tragedy, you’d face financial ruin. Buying homeowners insurance is clearly the right thing to do. In fact, it’s nearly impossible to find a lender who will write you a mortgage if you don’t have it.

How much homeowners insurance do I need?

You can shop various insurance companies, and each will have their own formula for determining how much it would cost to rebuild your home. Because they all look at similar characteristics of your house, such as its location, square footage and construction details, most estimates to cover your basic dwelling will be similar. You can choose extra coverage for special possessions or more liability protection, but your premiums will be higher.

Does homeowners insurance cover flooding?

Homeowners insurance does not cover damages from flooding. For that, you’ll have to purchase separate flood insurance. If you live near a river or other body of water that has a history of breeching its banks, you should budget for flood insurance. Likewise, a flood in your house due to a storm sewer backup or failed sump pump is not usually covered by homeowners. Homeowners insurance typically does cover water damage from burst pipes.

How is house insurance paid?

You renew your homeowners insurance annually, but most people choose to pay it in monthly increments as part of their mortgage payment. When you pay your mortgage, 1/12 of your annual insurance bill is sent to an escrow account (most people also include 1/12 of their annual property tax, as well). Your homeowners insurance is paid directly from your escrow account when it’s due.

Homeowners insurance is not only a good idea for your financial security and peace of mind, it’s required for you to get a home loan. Homeowners insurance will not only replace your home and possessions if an issue arises, it also provides you substantial liability protection. It adds to your monthly mortgage payment, but you’ll be very glad to have it when you need it — which hopefully you never will.

If you’re researching homeowners insurance and thinking more seriously about buying a house, the best way to get started is to apply for initial mortgage approval online today.