Homeowners Insurance Guide: A Beginner's Overview

Homeowners Insurance Guide: A Beginner's Overview

Homeowners insurance (also known as home insurance) isn't a luxury; it's a necessity. And not just because it protects your home and possessions against damage or theft. Virtually all mortgage companies require borrowers to have insurance coverage for the full or fair value of a property (usually the purchase price) and won't make a loan or finance a residential real estate transaction without proof of it.

You don't even have to own your home to need insurance; many landlords require their tenants to maintain renter's insurance coverage. But whether it's required or not, it's smart to have this kind of protection. We'll walk you through the basics of homeowners insurance policies.

KEY TAKEAWAYS

• Homeowners insurance policies generally cover destruction and damage to a residence's interior and exterior, the loss or theft of possessions, and personal liability for harm to others.
• Three basic levels of coverage exist: actual cash value, replacement cost, and extended replacement cost/value.
• Policy rates are largely determined by the insurer's risk that you'll file a claim; they assess this risk based on past claim history associated with the home, the neighborhood, and the home's condition.
• In shopping for a policy, get quotes from at least five companies, and definitely check with any insurer you already work with—current clients often get better deals.

What a Homeowner's Policy Provides

Although they are infinitely customizable, a homeowner's insurance policy has certain standard elements that provide what costs the insurer will cover.

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.1 For example, if your house is insured for $200,000, there would be up to about $140,000 worth of coverage for your possessions.

If you own a lot of high-priced possessions (fine art or antiques, fine jewelry, designer clothes), you might want to pay extra to put them on an itemized schedule, purchase a rider to cover them, or even buy a separate policy.

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. Or, if your kid breaks her Ming vase, you can file a claim to reimburse her. And if Doris slips on the broken vase pieces and successfully sues for pain and suffering or lost wages, you'll be covered for that, too, just as if someone had been injured on your property.

While policies can offer as little as $100,000 of coverage, experts recommend having at least $300,000 worth of coverage, according to the Insurance Information Institute. For extra protection, a few hundred dollars more in premiums can buy you an extra $1 million or more through an umbrella policy.

Hotel or House Rental While Your Home Is Being Rebuilt or Repaired

It's unlikely, but if you do find yourself forced out of your home for a time, it will undoubtedly be the best coverage you ever purchased. This part of insurance coverage, known as additional living expenses, would reimburse you for the rent, hotel room, restaurant meals, and other incidental costs you incur while waiting for your home to become habitable again. Before you book a suite at the Ritz-Carlton and order caviar from room service, however, keep in mind that policies impose strict daily and total limits. Of course, you can expand those daily limits if you're willing to pay more in coverage. 

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.

There are essentially three levels of coverage.

Actual cash value

Actual cash value 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).

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). “Often shoppers make the mistake of insuring [a house just] enough to cover the mortgage, but that usually equates to 90% of your home's value," says Adam Johnson, a home insurance product manager for policy comparison site QuoteWizard.com. "Due to a fluctuating market, it's always a good idea to get coverage for more than your home is worth." 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?

While homeowner's insurance covers most scenarios where a loss could occur, some events are typically excluded from policies, such as natural disasters or other "acts of God," and acts of war.

What if you live in a flood or hurricane area? Or an area with a history of earthquakes? You'll want riders for these or an extra policy for earthquake insurance or flood insurance. There’s also sewer and drain backup coverage you can add on, and even identity recovery coverage that reimburses you for expenses related to being a victim of identity theft.

How Are Homeowners Insurance Rates Determined?

So what's the driving force behind rates? According to Noah J. Bank, a vice president and insurance advisor at HUB International, it's the likelihood a homeowner will file a claim—the insurer's perceived "risk." And 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. “Claim frequency and severity of the claim play a considerable role in determining rates, especially if there's more than one claim relating to the same issue like water damage, wind storms, etc.,” Bank says.

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, notes Bank.

The 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.

“Pricing and eligibility for home insurance can also vary depending on an insurer’s appetite for certain building construction, roof type, condition or age of the home, heating type (if an oil tank is on-premise or underground), the proximity to the coast, swimming pool, trampoline, security systems, and more,” says Bank.

What else affects your rates? “The condition of your home could also reduce a home insurance company’s interest in providing coverage,” says Bill Van Jura, an insurance planning consultant in Poughkeepsie, N.Y. “A home that’s not well-maintained increases the odds the insurer will pay on a claim for damage.” Even the presence of a pup residing at your home can raise your home insurance rates. Some dogs can do a lot of damage, depending on the breed.

Cost-Cutting Insurance Tips

While it never pays to play it cheap with coverage, there are ways to cut down on insurance premiums.

Maintain a security system

A burglar alarm monitored by a central station or tied directly to a local police station will help lower the homeowner's annual premiums, perhaps by 5% or more. In order to obtain the discount, the homeowner must typically provide proof of central monitoring in the form of a bill or a contract to the insurance company.

Smoke alarms are another biggie. While standard in most modern houses, installing them in older homes can save the homeowner 10% or more in annual premiums. CO detectors, dead-bolt locks, sprinkler systems and in some cases even weatherproofing can also help.

Raise your deductible

Like health insurance or car insurance, the higher the deductible the homeowner chooses, the lower the annual premiums. However, the problem with selecting a high deductible is that claims/problems that typically cost only a few hundred dollars to fix—such as broken windows or damaged sheetrock from a leaky pipe—will most likely be absorbed by the homeowner. And these can add up.

Look for multiple policy discounts

Many insurance companies give a discount of 10% or more to customers who maintain other insurance contracts under the same roof (such as auto or health insurance). Consider obtaining a quote for other types of insurance from the same company that provides your homeowners insurance. You may end up saving on two premiums.

Plan ahead for renovation

If you plan to build an addition or adjacent structure to your home, consider the materials that will be used. Typically, wood-framed structures will cost more to insure because they are highly flammable. Conversely, cement- or steel-framed structures will cost less because these are less likely to succumb to fire or adverse weather conditions.

Another thing most homeowners should, but often don't, consider are the insurance costs associated with building a swimming pool. In fact, items such as pools and/or other potentially injurious devices (like trampolines) can drive the annual insurance costs up by 10% or more.

Pay off your mortgage

Obviously this is easier said than done, but homeowners who own their residences outright will most likely see their premiums drop. Why? The insurance company figures if a place is 100% yours, you'll take better care of it.

Make regular policy reviews and comparisons

No matter what initial price you're quoted, you'll want to do a little comparison shopping, including checking for group coverage options through credit or trade unions, employers, or association memberships. And even after purchasing a policy, investors should, at least once per year, compare the costs of other insurance policies to their own. In addition, they should review their existing policy and make note of any changes that might have occurred that could lower their premiums.

For example, perhaps you have disassembled the trampoline, paid off the mortgage, or installed a sophisticated sprinkler system. If this is the case, simply notifying the insurance company of the change(s) and providing proof in the form of pictures and/or receipts could significantly lower insurance premiums. “Some companies have credits for complete upgrades to plumbing, electric, heat, and roof,” says Van Jura.