Homeowners insurance (also known as home insurance) isn’t a luxury; it’s a necessity. That’s not just because it protects your home and possessions against damage or theft. In this article, we’ll walk you through the basics of homeowners insurance policies.
Most mortgage companies require borrowers to have insurance coverage for the replacement cost of a property, which is the cost to rebuild it if it is completely destroyed. Your insurer will likely pay your settlement to both you and your lender if that happens.
You don’t even have to be a homeowner to need insurance. Many landlords require their tenants to maintain renters insurance coverage. Whether it’s required or not, it’s smart to have this kind of protection.
What a Homeowners Policy Provides
Although they are infinitely customizable, a homeowners insurance policy has certain standard elements that provide what costs the insurer will cover. Each of the main coverage areas are discussed below.
Damage to the Interior or Exterior of Your House
In the event of damage due to fire, hurricanes, lightning, vandalism, or other covered disasters, your insurer will compensate you so your house can be repaired or even completely rebuilt. Destruction or mutilation from floods, earthquakes, and poor home maintenance is generally not covered, and you may require separate riders if you want that type of protection. Freestanding garages, sheds or other structures on the property may also need to be covered separately using the same guidelines as for the main house.
Clothing, furniture, appliances, and most of the other contents of your home are covered if they’re destroyed in an insured disaster. You can even get “off-premises” coverage, so you could file a claim for lost jewelry, say, no matter where in the world you lost it. There may be a limit on the amount your insurer will reimburse you, however. According to the Insurance Information Institute, most insurance companies will provide coverage for 50% to 70% of the amount of insurance you have on the structure of your home.Personal Liability for Damage or Injuries
Liability coverage protects you from lawsuits filed by others. This clause even includes your pets! So, if your dog bites your neighbor, Doris, no matter if the bite occurs at your place or hers, your insurer will pay her medical expenses. Alternatively, if your kid breaks her Ming vase, you can file a claim to reimburse her. If Doris slips on the broken vase pieces and successfully sues for pain and suffering or lost wages, you’ll likely be covered for that, too, just as if someone had been injured on your property.
Different Types of Homeowners Coverage
All insurance is definitely not created equal. The least costly homeowners insurance will likely give you the least amount of coverage, and vice versa.
In the U.S. there are several forms of homeowners insurance that have become standardized in the industry; they are designated HO-1 through HO-8 and offer various levels of protection depending on the needs of the homeowner and the type of residence being covered.
Many states also offer plans that provide basic coverage to property owners located in zones considered high-risk. These Fair Access to Insurance Requirements (FAIR) plans are a last-resort insurance coverage.
There are essentially three levels of coverage.
Actual Cash Value
Actual cash value (ACV) covers the cost of the house plus the value of your belongings after deducting depreciation (i.e., how much the items are currently worth, not how much you paid for them). Some policies may contain a recoverable depreciation clause, which allows the owners to claim the value of the depreciation along with the ACV.
Replacement Cost
Replacement value policies cover the actual cash value of your home and possessions without the deduction for depreciation, so you would be able to repair or rebuild your home up to the original value.
Guaranteed (or Extended) Replacement Cost/Value
The most comprehensive, this inflation-buffer policy pays for whatever it costs to repair or rebuild your home—even if it’s more than your policy limit. Certain insurers offer an extended replacement, meaning it offers more coverage than you purchased, but there is a ceiling; typically, it is 20% to 25% higher than the limit.
Some advisors feel all homeowners should buy guaranteed replacement value policies because you don’t need just enough insurance to cover the value of your home, you need enough insurance to rebuild your home, preferably at current prices (which probably will have risen since you purchased or built). Guaranteed replacement value policies will absorb the increased replacement costs and provide the homeowner with a cushion if construction prices increase.
What Isn’t Covered by Homeowners Insurance?
Homeowners insurance policies typically include coverage for a wide range of perils and events that can cause damage to your property or belongings. However, there are also several common exclusions, which are situations or events that are not covered by the standard policy. If you want coverage for many of these specific items, you’ll likely need to buy separate or private coverage.
There are several natural disaster occurrences that are not covered by standard coverage. Standard homeowners insurance usually doesn’t cover damage caused by floods. Earthquake damage is typically excluded from standard homeowners insurance policies. While some policies include limited coverage for sudden and accidental sinkhole damage, extensive or gradual sinkhole damage is often excluded as well.
There are some home repair and maintenance costs that are not covered. Many standard policies exclude damage from sewer or drain backups. Repairs or replacements due to the normal course of use are also generally not covered. Damage caused by termites, rodents, other pests, mold, and mildew may also be excluded, especially if prevention methods are not taken.
Last, there are many acts that do not constitute coverage. Damage caused by acts of war, terrorism, or civil unrest is usually not covered by standard homeowners insurance policies, nor is damage from nuclear accidents or radiation. If you intentionally cause damage to your own property, it is unlikely to be covered by your insurance policy. In addition, if you need to rebuild or repair your home to comply with updated building codes or laws after a covered loss, the additional costs might not be fully covered by a standard policy.
How Are Homeowners Insurance Rates Determined?
So what’s the driving force behind rates? In general, rates are set based on the likelihood a homeowner will file a claim—the insurer’s perceived “risk.” To determine risk, home insurance companies give significant consideration to past home insurance claims submitted by the homeowner as well as claims related to that property and the homeowner’s credit.
While insurers are there to pay claims, they’re also in it to make money. Insuring a home that has had multiple claims in the past three to seven years, even if a previous owner filed the claim, can bump your home insurance premium into a higher pricing tier. You may not even be eligible for home insurance based on the number of recent past claims filed, says Noah J. Bank, a vice president and insurance advisor at HUB International,
Neighborhood, crime rate, and building material availability will all play a part in determining rates, too. And, of course, coverage options such as deductibles or added riders for art, wine, jewelry, etc.—and the coverage amount desired—also factor into the size of an annual premium.
What else affects your rates? Generally speaking, almost anything that impacts potential risk may impact your rate. For instance, a home that is not well-maintained may increase the necessity for major damages. Another example is a home with a specific breed of dog that may be more susceptible to damage. At a high level, rates are set based on the likelihood of the insurer paying out damages. The more variables that contribute to that risk, the higher your rates.