Homeowners Insurance: What It Is and What It Covers

Mortgage lenders generally require homeowners insurance coverage, and it’s almost always a smart investment.
Doug SiborAug 18, 2021

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What’s inside

Your home is more than just a roof over your head. It may be your most valuable asset — and one you likely can’t afford to replace out-of-pocket if disaster strikes. That’s why protecting your investment with the right homeowners insurance coverage is so important.

Homeowners insurance will compensate you if an event covered under your policy damages or destroys your home or personal items. It will also cover you in certain instances if you injure someone else or cause property damage. Homeowners insurance has three main functions:

Homeowners insurance coverage isn’t required by law, but if you have a mortgage, your lender will likely require you to insure the home to protect its investment. Even if you don’t have a mortgage, home insurance is almost always a wise purchase, giving you both property and liability coverage.

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Standard homeowners insurance policies generally include six types of coverage.

Homeowners insurance comes in several types, called “policy forms.” Some types provide more expansive coverage than others, so it’s worthwhile to know the difference. Although details can differ by state and company, these kinds are fairly standard.

HO-3 insurance policies, also called “special form,” are by far the most common. HO-3 insurance accounted for nearly 80% of coverage on owner-occupied homes in 2018, the most recent year for which data is available, according to the National Association of Insurance Commissioners. If you have a mortgage, your lender is likely to require at least this level of coverage.

HO-3 insurance policies generally cover damage to your home from any cause except those the policy specifically excludes, such as an earthquake or flood. However, where it concerns your belongings, an HO-3 policy typically covers only damage from 16 “named perils” unless you buy extra coverage:

An HO-5 insurance policy provides the most extensive homeowners coverage. It pays for damage to your home and belongings from all causes except those the policy excludes by name. HO-5 insurance accounted for about 13% of homeowners coverage in 2018, according to the NAIC. It’s typically available only for well-maintained homes in low-risk areas, and not all insurers offer it.

Much less popular are HO-1 and HO-2 homeowners insurance, which pay out only for damage caused by issues listed in the policy. Together these two types account for about 8% of homeowners coverage. HO-2 insurance, the more common of the two, typically covers your house and belongings only for the 16 causes listed above. HO-1, which isn’t widely available, is the most bare-bones type of homeowners insurance. It covers losses from an even shorter list of perils than the HO-2 form.

Other policy types include HO-4 insurance for renters, , HO-7 for mobile homes and HO-8, a rarely used type that provides limited coverage for older homes.

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If your home is destroyed, your homeowners insurance company isn’t likely to simply write you a check for the amount listed on your policy. Your payout could differ depending on the cost to rebuild and the coverage you chose — and much of it will be paid directly to contractors rebuilding your home, in many cases.

One key decision is whether to choose coverage that will pay whatever it takes to rebuild your home, even if that cost exceeds your policy limits. This situation may arise, for instance, if construction costs have increased in your area while your coverage has remained level. Here’s a rundown of several options you may encounter.

Actual cash value coverage pays the cost to repair or replace your damaged property, minus a deduction for depreciation. Most policies don’t use this method for the house itself, but it’s common for personal belongings. For items that are several years old, this means you’ll probably get only a fraction of what it would cost to buy new ones.

Functional replacement cost value coverage pays to fix your home with materials that are similar but possibly cheaper. For example, damaged plaster walls could be replaced with less expensive drywall.

Replacement cost value coverage pays to repair your home with materials of “like kind and quality,” so plaster walls can be replaced with plaster. However, the payout won’t exceed your policy’s dwelling coverage limits.

Some policies offer replacement cost value coverage for your personal items. This means the insurer would pay to replace your old belongings with new ones, with no deduction for depreciation. If this feature is important to you, make sure to check the policy details before you buy — this is a common option, but you typically need to pay up for it.

Extended replacement cost value coverage will pay out more than the face value of your dwelling coverage, up to a specified limit, if that’s what it takes to fix your home. The limit can be a dollar amount or a percentage, such as 25% above your dwelling coverage amount. This gives you a cushion if rebuilding is more expensive than you expected.

Guaranteed replacement cost value coverage pays the full cost to repair or replace your home after a covered loss, even if it exceeds your policy limits. Not all insurance companies offer this level of coverage.

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Even the broadest homeowners insurance policy won’t cover everything that could possibly go wrong with your home. For example, you can’t intentionally damage your own house, then expect your insurer to pay for it. Policies also typically exclude damage from other causes, such as:

However, you can buy separate coverage for some of these risks. and are available separately, and in hurricane-prone states, you may also need or want windstorm insurance.

Talk to your insurer if you have concerns about damage and events your policy doesn’t cover. In many cases, you can add what are called endorsements — which usually cost extra — to provide more coverage.

Below are a few of the most common home insurance endorsements. Note that availability may vary by state and company.

Scheduled personal property covers a specific valuable item, such as a ring or musical instrument. An appraisal may be required.

Ordinance or law coverage pays to bring your home up to current building codes during repairs or rebuilding.

Water backup coverage pays for damage due to backed-up sewer lines, drains or sump pumps.

Equipment breakdown coverage pays for HVAC systems and large appliances if they stop working for reasons other than normal wear and tear.

Service line protection pays for damage to water, electric or other utility lines that you’re responsible for.

Identity fraud coverage pays expenses associated with identity theft, such as lost wages and legal fees.

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You need enough homeowners insurance to cover the cost of rebuilding your home if it’s destroyed. To estimate your rebuilding cost, multiply the square footage of your home by local construction costs per square foot. Your home insurance agent or insurer should be able to help you calculate the replacement cost.

Don’t focus on what you paid for the house, how much you owe on your mortgage, your assessment or the price you could get if you sell. If you base your coverage on those numbers, you could end up with the wrong amount of insurance. Instead, set your dwelling coverage limit at the cost to rebuild. You can be confident you’ll have enough funds for repairs, and you won’t be paying for more coverage than you need.

For “personal property,” your belongings, you’ll generally want coverage limits that are at least 50% of your dwelling coverage amount, and your insurer may automatically set the limit that way. However, you can lower this limit if needed or purchase extra coverage if you think the limit isn’t enough to cover your things.

A thorough home inventory is the best way to pinpoint how much it would take to replace all your stuff. An inventory record can also come in handy later if you have to make a claim and need to know exactly what you lost. You could make a list or, as a quick inventory hack, use your smartphone to take video of all your furniture, clothing and other belongings.

Consider setting your liability limit at least high enough to cover your . That includes the value of your savings, investment accounts and other assets, minus auto loans, credit card balances and other debts.

You may want a higher limit if your lifestyle puts you at greater risk of being sued — for example, if you have a swimming pool, regularly host parties in your home or participate in activities where you could injure others, such as hunting or skiing.

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Homeowners policies typically include an — the amount you’re required to cover before your insurer starts paying. The deductible can be:

When you receive a claim check, your insurer subtracts your deductible amount. For instance, if you have a $1,000 deductible and your insurer approves a claim for $10,000 in repairs, the insurer would pay $9,000 and you would be responsible for the remaining $1,000.

Be aware that some policies include separate — and often higher — deductibles for specific types of claims, such as damage from wind, hail, or earthquakes. For example, a policy might have a $1,000 deductible for most losses but a 10% deductible for optional earthquake coverage that was added to the policy. This means if an earthquake damages a home with $300,000 worth of dwelling coverage, the deductible would be $30,000.

Liability claims generally don’t have a deductible.

The  is $1,585 a year, according to a NerdWallet analysis. But prices can skew much higher or lower, depending on your location and the amount of coverage you buy. In most states, your credit score can also be a factor.

If your premium seems too high, there are easy ways to . For example, many insurers offer a discount for bundling your home and auto insurance. You might also get a lower rate for having common safety features, such as burglar alarms and deadbolt locks. And it’s always a good idea to shop around and compare to make sure you’re getting the best deal.

Before getting too stressed over the cost of your policy, remember this coverage gives you considerable bang for your buck. The premium you pay will be a fraction of the cost to rebuild your home from the ground up and replace your possessions.

Methodology

NerdWallet averaged rates for 40-year-old men and women from insurance companies in every ZIP code across all 50 states and Washington, D.C. Sample homeowners were nonsmokers with good credit living in a single-family, two-story home built in 1971. They had a $1,000 deductible and the following coverage limits:

These are sample rates generated through Quadrant Information Services. Your own rates will be different.

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