Homeowners Insurance: Everything You Need to Know Before You Buy was written by Jeff Cooper and originally appeared on Your Money Geek. It has been republished with permission.
Buying a home is a big deal and a significant investment. For most of us, our house is our biggest expense. But, more importantly, our house is our home. It's where we relax, rest our heads at night, probably work from now, and it's what keeps us, our family's, and all of our stuff safe.
Our homes are essential pieces of our lives, and if something were to happen to them, it would need to get fixed. Issues vary from minor fixes to major problems. These major issues can keep some people up at night as they can get extremely costly; this is where homeowners insurance comes in.
What Is Homeowners Insurance?
At its core, homeowners insurance is an insurance policy that covers losses and damages to your home and assets in the house. A typical homeowners policy typical covers:
- Damages to the exterior of a home
- Damages to the interior of a home
- Loss or damage to personal assets
- Injuries that occur on the property
In addition to these coverages, if you live in an area prone to natural disasters, also known in the insurance business as “Acts of God,” you may also have policy coverage for disasters such as:
- Other uncontrollable events
Of course, with these extra protections/coverages comes additional cost. As a result, most people choose not to include coverage for such events as they do not happen enough or at all in the areas in which they live.
Another rarely used coverage (at least in the US) is the “War Risk” coverage, which would cover damages incurred from events such as war, invasions, insurrections, riots, strikes, and terrorism.
Homeowner insurance policies typically include additional living expenses (ALE) coverage. One might incur extra costs from living away from home if it becomes uninhabitable due to damage from an insured scenario.
Three Types of Homeowners Insurance
There are different types of insurance coverages in the US, and depending on which one you choose, it will change the amount you might receive from a claim.
Actual Cash Value
With actual cash value coverage, you'd be covered for the cost (how much you paid) of your home and belonging after accounting for depreciation (how much the house and belongings are currently worth). Likely, this would mean you would receive less for your home and belongings than you originally paid.
Replacement value policies are the same as actual cash value except it does not take depreciation into account. This would mean you would be able to receive the amount you originally paid for both your home and possessions.
Guaranteed (or extended) Replacement Cost/Value
GRC is the most comprehensive type of coverage. This type of coverage will allow you to receive the total cost of repairing or rebuilding your home, even if it's more than your policy limit. The reason for this is that the prices of repairing or rebuilding have likely risen since you purchased your home, and this type of coverage will take that into account. There is a limit to how much over your policy limit you can receive, typically 20% to 25%.
Many experts believe homeowners should have GRC as costs almost always rise when repairing/rebuilding a home and many homeowners are stuck footing the bill if a total rebuild is needed.
How Much is Homeowners Insurance?
Like most insurance policies, the policyholder pays a premium each month to maintain the policy. The premium paid each month can vary based on many factors. Some of the more common factors are:
- Where you live
- The price of your home and the cost to rebuild it
- The amount of coverage
- Your home's age and condition
- Home security and safety features
- Your credit history
- Additional types of coverage
- Your deductible
- Bundling other insurance from the same company
- Your choice of insurance provider
Using these and other factors, insurance companies will determine how much of a monthly payment they will require to cover the cost of any potential damages to a home. For example, the more it will cost to rebuild your home, the higher your premium.
Conversely, choose a higher deductible, which is the amount you pay for any damages before insurance kicks in the rest. As a result, your monthly premium will be slightly lower.
How Does Home Owners Insurance Work?
Like other insurance policies, homeowners insurance will cover the costs of making any repairs due to covered damages after the deductible has been paid. For example, you can make an insurance claim if you incur water damage or damage from a fire.
Your insurance company will likely send a claims adjuster to your home to inspect the damage. The claims adjuster is there for several reasons. For one, they are the first line of defense against insurance fraud.
They will examine the damage and speak to any relevant people who may help confirm the claim happened the way the homeowner says it did. Claims adjusters will also determine if the homeowner's policy covers the damage and how much damage the insurance company is responsible for.
Once it is deemed everything is on the up and up, a homeowner will pay the deductible. The insurance company will cover the rest. Back to our fire/water damage example, if your deductible is $2,000 and it's been determined that you have $10,000 in damages, you'd pay the first $2,000. The insurance company would pay the remaining $8,000.
How and When to Get Homeowners Insurance
Most banks will require proof of insurance before lending money to potential homeowners. You can obtain policies through the bank or lending institution itself, or homeowners may choose to get the policy independently.
There are tons of insurance companies out there, both large and small. Each will have different packages and price ranges, so getting more than one quote is essential before agreeing to any policy.
Once the policy is in place, the mortgage lender can release the funds needed to purchase the property. The insurance premium is typically included in the mortgage payment and held by the lender in an escrow fund. When the bill comes due from the insurance company, the mortgage company will take care of payment from this fund. If you are lucky enough not to have a mortgage, you will pay the insurance company directly.
How Much Coverage Do I Need?
When determining the amount of coverage you'll need, it's crucial to make sure you are not only considering the current worth of your home. Most claims are for repairs, and the insurance policy will be more than enough to cover the costs. However, in the worst possible scenario, you might have to rebuild your home completely.
Many policies will fall short if proper consideration isn't taken. Many policyholders will only have the mortgage or the purchase price of the house as their covered amount. When a rebuild happens, these policies fall very short.
For example, let's say you purchased a home for $300k with 20% down for a mortgage of $240k. Now the price of the home has risen to be $340k. If you took out a policy with $300k in coverage, you'd fall 40k on rebuilding. If you took out only the mortgage amount at $240k, you'd fall 100k short of the rebuilding costs.
Unless you have the GRC coverage mentioned earlier, you could be stuck with a smaller house or getting stuck adding additional funds to your mortgage.
It's Not the Same As a Home Warranty
Homeowners insurance and a home warranty are commonly confused, but they are not the same thing. While homeowners insurance covers the damages to your home, a home warranty typically covers the cost of replacing/repairing different appliances or systems in your home. Appliances could include your washer, dryer, dishwasher, oven, or water heater. A home warranty would typically cover systems like your heating and cooling systems.
Home warranties can vary in price depending on the duration of the warranty and what is being protected. Unlike homeowners insurance, home warranties are not required when potential owners are looking to secure a mortgage. They are simply an optional policy to cover any “wear-and-tear” costs owners might incur. They usually are more popular with landlords of investment properties.
How to Keep Your Premiums Lower
Obviously, everyone would like to keep their insurance premiums as low as possible. However, don't cheap out on coverage as anything you save there. You'll pay tenfold if any should ever happen. Here are some better ways to keep your premium costs down.
Have a Higher Deductible
As mentioned above, having a higher deductible will lower your premium. Basically, the more you cover, the less the insurance company needs to, so you are less liable to them. Make sure not to go too high, though, as then you'll be paying for most minor repairs on your own as you won't reach the deductible.
Get a Home Security System
Again, you'll be seen as less of a liability to an insurance company by having a home security system. Not only will you be less likely to be burglarized, but security systems are also typically connected to local police and fire departments. These departments will automatically be alerted to any emergency that may be taking place in your home, whether you are there or not.
Any other security measures will help as well. For example, simple updates such as installing smoke detectors, carbon monoxide (CO) detectors, or deadbolt locks can all help lower your premium.
Stick With One Insurance Company
Many insurance companies provide more than just homeowners insurance. By maintaining multiple policies with the same company, you'll be likely to get a discount on both, double savings!
Build With The Right Materials
When planning a renovation/addition or other home improvements, take the building materials into account. By doing home renovations or additions, you add value to your home, which could mean a rise in your premium. The materials used could change how much of a rise. More often than not, structures mostly made from wood are more expensive to insure than structures using concrete or steel. The logic is simple. Wooden structures are more susceptible to fire and other wear and tear than other materials. They are therefore more likely to need repairs down the road.
Pay Off Your Mortgage
Not exactly easy to accomplish, but insurance companies do take this into account sometimes. The reason is that many insurance companies believe that once a home is completely paid off, homeowners are more likely to take better care of it, simple as that.
Homeowners insurance is not only essential to have when owning a home; it's required. It would be best if you never rushed into a policy. Make sure you not only have enough to insure the total cost of your home and belongings now but what it might cost to replace everything in 5,10, or 15 years. It will likely raise your premium, and hopefully, you never use it, but if you ever do, you'll be glad you did. You can reduce your premiums in other ways to help offset the costs of increased coverage.