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Homeowners Insurance Guide - What Is It, Requirements & What It Covers

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Published on April 2, 2021
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Buying a home requires a major investment. In fact, it might be the most valuable investment you ever make. That’s why protecting your home (and yourself) with homeowners insurance is important. If something were to happen to your home, the loss or damage may be far too expensive to cover out of pocket. However, not all homeowners insurance is created equal.

Several factors determine what type of homeowners insurance policy you should get and how much you’ll end up paying. Identifying these factors and how they affect you will help you figure out the coverage you need for your home.

What Is Homeowners Insurance?

Homeowners insurance works as a safety net to protect your home and finances. If you experience any damage or theft to your property, your homeowners insurance would typically cover the cost necessary to bring your property back to its original value.

How Does Homeowners Insurance Work? 

Typically, homeowners insurance is paid through an escrow account. This is a type of savings account used for paying off parts of your mortgage. Unless you’re handling your homeowners insurance payments on your own, the annual premium is added to your mortgage payment. 

This means you pay off your insurance premium in monthly installments rather than all at once. A smaller, monthly rate gives you extra stability when creating a budget and managing your mortgage payments.

While most lenders typically require escrow on your mortgage, some may give you the option to waive it. This would allow you to manage and pay your homeowners insurance directly through the insurance provider. Keep in mind: choosing this option, if available, would mean paying your annual premium in one lump sum, which can be quite expensive.

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Is Homeowners Insurance Required? 

While homeowners insurance isn’t required by law, your lender or mortgage investor will require that you have an insurance policy on your home before they give you a loan.

What Does Homeowners Insurance Cover? 

While the most basic protection covers damage to the home itself, homeowners insurance can cover damages to other structures around your home, stolen or damaged personal property, and liability in the event someone injures themselves on your property. Let’s take a closer look.

Damage To Your Home

The most basic protection offered by homeowners insurance covers damage to the physical structure of your home. Damage from normal wear and tear to your home would not be covered. 

Damage To Other Structures On Your Property

Many policies include protection for structures outside of your home that still dwell on your property such as a detached garage, shed or fence.

Damage Or Theft Of Personal Property

Your policy may cover your personal property, not just within your home, but the property you have in your possession when you’re not home. With personal property coverage, the insurer usually sets limits on things like jewelry and other high-value items. However, additional coverage may be offered in the form of riders. A rider is a provision in your insurance policy that adds to or amends the coverage terms.

Liability

If someone injures themselves on your property, liability insurance helps cover the claim made for medical costs as well as your legal costs if a lawsuit occurs. Liability can also protect you against damage to your neighbor’s property such as a tree in your yard falling on their roof.

Homeowners insurance doesn’t just protect you and your home. It protects the lender’s investment in your home. This is why they require it to approve your mortgage. If you have a mortgage, you’re required to get homeowners insurance coverage for at least the full replacement value of your property. If damage occurs and a repair needs to be done, an inspection is required to make sure the home’s value is restored.

How Much Does Homeowners Insurance Cost?

Where you live plays a major role in how much you pay for homeowners insurance. Typically, homeowners insurance rates vary by state. 

Along with your home’s location, the home itself can determine how much you pay for insurance. This includes the home’s condition and age. Insurance companies may charge a higher premium for an older home or one that isn’t properly maintained. Even the contents inside your home can determine what you pay.

Your credit score can also play a role in how much you pay for homeowners insurance. Just like with a credit card or mortgage, a higher credit score may lead to a better rate, which will save you money.

As with any insurance, you can save money by increasing your deductible, which will lower the amount you pay toward your premium. How much you save and whether doing this makes sense depends on your coverage and the state you live in.

How Much Home Insurance Do I Need? 

Home insurance can offer a large amount of financial protection. If something goes awry, policyholders can receive payout for property damage, destroyed personal belongings and liability protection.

With that said, the more coverage you have, the more you'll have to pay in insurance premiums. If you have the money and want the peace of mind, there's insurance products to cover everything. If you're savvier, you'll want to assess what you really need coverage for and what you can risk.

What Different Types Of Homeowners Insurance Are Available? 

There are many different types of homeowners insurance products. Chances are if it exists and there's a risk of it being damaged, there's an insurance product for it. Home insurance coverage can range from the most basic forms to comprehensive coverage.

This article specifically addresses residences that are stick-built homes. For apartments, you should research HO-4 insurance, or renters insurance. If you want to insure your condo, check out HO-6 insurance.

Let's dig into some coverage options and terms you need to know, then we'll cover four of the most common types of homeowners insurance.

Actual Cash Value

Actual cash value is an insurance coverage term that takes into account the depreciation of the item that's covered. If you paid $1,000 for an item and the insurance company determines the value has dropped to $700, an insurance policy covering the actual cash value of the item will pay out $700. 

Replacement Cost

Replacement cost coverage is an option for property insurance that covers the cost to replace the item. Sort of, anyway. If you paid $1,000 for the item, the insurance company will calculate, based on inflation, how much it costs to replace the item. This usually means the price you paid multiplied by the inflation rate. 

This isn't necessarily what it actually costs to replace the damaged property. Many items appreciate in value over time. Collectibles, jewelry, instruments, etc. will all need their own additional policy coverage if you want to be covered for exactly what they're worth. 

Guaranteed Replacement Cost

Guaranteed replacement cost comes into play when something devastating happens to your home. There's a lot of weight on the word "guaranteed" here. Let's say you buy the home of your dreams, replete with granite countertops, custom molding and everything your heart desires. 

In the event of an insurance-covered catastrophe, the actual cost to replace the home from scratch is probably more than what you paid for the home, given construction costs. Guaranteed replacement cost coverage will cover the whole expense of replacing your home. 

Additional Living Expense

Additional living expense (ALE) coverage includes extra costs incurred if you’re displaced from your home. This includes paying for staying at hotel, as well as food, storage and other amenities. ALE coverage is included in most homeowners insurance policies.

HO-1 And HO-2 Insurance

HO-1 and HO-2 are two types of lower-cost homeowners insurance. Let's start with HO-1.

HO-1, aka "basic form," covers the fundamental types of what the insurance industry refers to as "peril." These types are:

  • Damage from aircraft or vehicles
  • Explosions
  • Fire and lightning
  • Hail and windstorms
  • Riots
  • Smoke
  • Theft
  • Vandalism
  • Volcanic eruption

As you can see, this basic form insurance is lacking in many types of covered loss. Because of how basic this insurance is, many companies do not offer it.

HO-2 insurance, aka "broad form," is a step up from HO-1. It covers the same types of peril as HO-1, as well as damage caused to or by faults in intrinsic home systems. For instance, if the pipes in your sprinkler system freeze and burst, it's covered under HO-2

Even though HO-2 is referred to as "broad form," it isn't all that broad in coverage. HO-2 is a "named peril" insurance type, meaning that what's covered is what's named in the policy.

HO-3 Insurance

H0-3 Special Form home insurance goes a few steps further than HO-2. According to the Insurance Information Institute, HO-3 insurance is the most popular type. It covers you against many environmental hazards and protects your personal property. It includes some personal liability coverage, so if you're sued for something, the insurance may step in.

HO-3 insurance policies are exclusionary, which means all perils are covered except for the exclusions named. Common exclusions include wear and tear, power failure, foundation problems and the presence of mold or vermin on the property. These exclusions can vary and the lists can be lengthy, so compare policies when you're getting homeowners insurance quotes.

HO-5 Insurance

HO-5 Comprehensive Form  is the most expensive home insurance policy. These policies can be similar to HO-3s, but with more coverage. HO-5 level insurance is usually only available to certain homes, typically newer, well-maintained builds close to the fire department. 

Like HO-3s, HO-5 policies are exclusionary. Their list of perils not covered by insurance is shorter than HO-3s. Some exclusions are war, government action, floods and nuclear hazards.

What Isn’t Covered In Homeowners Insurance? 

The most common exceptions you need to be concerned about involve environmental damage. These include flood damage and fire damage. Flood insurance is typically not included in most insurance policies, and you’ll have to purchase it if your home is located in a high-risk flood area. These areas include homes in flood zones and states regularly impacted by hurricanes.

Likewise, if you live in or near a forested area, or an area that experiences drought, you may need to buy additional coverage in case of a wildfire. In fact, additional hazard insurance may be required in these areas.

Other exclusions that most home insurance companies do not cover include nuclear hazards, pets, earthquakes and erosion.

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Choosing A Home Insurance Provider

If you’re wondering how to find the right home insurance agent, here’s what you need to know.

Meet With A Local Home Insurance Agent

The keyword here is “local.” While HOI policies are complex and confusing, working with someone who understands insurance isn’t enough. You should speak to an agent who knows your area very well. Local agents understand local issues.

Some cities, or even neighborhoods, can have localized risks that affect the policy you may need. For example, let’s say you don’t live in a climate where frequent storms or flooding occur. However, your home just happens to be in an area with a history of faulty water pipes that are prone to backups. In this case, it might be best to have a policy with hazard insurance to cover potential flood damage. A local insurance agent would have insight into this issue. Because you don’t live in a flood zone, a national insurance company might overlook it.

Why Choose An Independent Agent

Independent insurance agents may benefit you for several reasons. They aren’t tied to a specific insurance company. This allows them to focus on you rather than trying to fit you into a policy within a single company. Your goals, needs and budget are carefully considered as opposed to a company-specific agent who may just try to get you the lowest price.

Working with an independent agent may also eliminate the stress that comes with making a bunch of phone calls and filling out a handful of online quote forms. They can do all of that for you. Even after you take out an HOI policy, an independent agent will stay in touch with you to make sure you’re in good hands and address any questions or concerns you may have along the way.

Filing A Home Insurance Claim

No homeowner wants to face an event where they have to file an insurance claim, but it’s best to be prepared if disaster strikes. Here’s the typical process for filing a claim with a homeowners insurance company.

Contact Your Insurance Company

This is the first thing you should do. Don’t attempt to repair the damage yourself. Instead, let them tell you what to do next. If the damage to your home requires immediate attention, they may have you call a professional to make the repair and ask you to keep the invoice so you can be compensated at a later time.

Evaluate The Damage

Your HOI company will send in an insurance adjuster to evaluate the damage to your property. An itemized list of necessary repairs and costs will be given back to the insurance company.

Make Repairs

After the damage is assessed by the adjuster and reviewed by your insurance company, it’s best to have your insurance company select a contractor to make the repairs rather than handling it yourself. Going this route will ensure that the repairs are properly completed and may even be guaranteed for a certain number of years.

Inspect The Repairs

It’s typical for your insurance company to require an inspection of the repairs, especially if the amount of your claim amount is high. The inspector will use the list of repairs created by the adjuster to make sure all repairs are completed and up to par. Having an inspector protects you against any substandard work completed by the contractor.

After the claim is filed and the repairs are made, it’s possible that your HOI costs will go up. It’s not guaranteed that you’ll end up paying more, but you should be prepared just in case.

You’re Never In This Alone

Finding the right homeowners insurance policy is something you should never have to figure out on your own. Perilous exclusions, pricing, policy limits and so many coverage options can make the process seem daunting.

With access to local, independent insurance agents in your area, you don’t have to do it alone. It still helps to understand how homeowners insurance protects your home. Now that you know what to expect if the unfortunate happens, you’ll be prepared for it.

Interested in changing homeowner insurance policies? Read our guide on what you should know.

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Call our Home Loans Experts at (800) 251-9080 to begin your mortgage application, or apply online to review your loan options.

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Andrew Dehan

Andrew Dehan is a professional writer who writes about real estate and homeownership. He is also a published poet, musician and nature-lover. He lives in metro Detroit with his wife, daughter and dogs.