What Is Homeowner’s Insurance?
Home insurance can provide financial protection against the range of losses and liabilities that a homeowner might face. Common risks include fires, natural disasters, and lawsuits from others injured on your property.
Any of these unfortunate events can lead to a personal financial disaster in the absence of homeowner’s insurance. In fact, almost all mortgage lenders require some level of homeowner’s insurance to protect their investment. Whether you already own a home or are considering purchasing one, this brief overview is intended to put you on the path to reducing the risks that come with homeownership.
The Main Classifications of Coverage
Depending on the policy that your purchase, homeowner’s insurance can cover several different types of losses. The coverages are usually broken down into the following classifications:
With dwelling coverage, you can insure the value of your home against the risk of fire, wind, hail, or vandalism. Dwelling coverage will cover damage or destruction of your house and permanent fixtures (e.g. plumbing or HVAC systems) but it does not include the value of your land.
Sheds, garages, fences, and guest cottages that are not attached to your house are all typically classified as “Other Structures” on homeowner’s policies. Coverage for Other Structures is often limited to 10% of your Dwelling coverage limit, unless otherwise agreed to by your insurance company.
Personal Property includes furniture, appliances, clothing, electronics and other possessions. Many policies will cover your Personal Property that is damaged, destroyed, or stolen even if it was not actually on your property at the time of the event.
If you need to stay in a hotel or rent an apartment while your home is being repaired (e.g. after a fire), Loss of Use coverage will pay for some of the associated living expenses. If you are insuring a home that you rent out to tenants, Loss of Use may reimburse you for the fair market rental value while the home is unoccupied for repairs.
Liability coverage provides you with financial protection if you are sued for injuries or damages to another person. If your golden retriever bites someone who then sues you for negligence, Liability coverage will help pay for your legal expenses and the settlement or payout.
Medical Payments coverage pays for the medical bills of someone (not a member of your household) who is injured while on your property. This coverage usually extends to situations where a person is injured not on your property but the injury was caused by you, a family member, or your pet. Importantly, Medical Payments coverage covers medical expenses regardless of your legal liability.
Actual Cash Value vs. Replacement Cost
Homeowner’s insurance companies typically use one of two methods to calculate their contribution towards repairs or replacement of homes or personal property: Actual Cash Value and Replacement Cost.
If your policy provides Actual Cash Value, the insurance company’s contribution will be reduced based on the age and depreciated value of your home or personal property. Actual Cash Value is often not enough to rebuild the home to the same quality it was in before it was destroyed.
As the name suggests, a Replacement Cost policy is designed to cover the full cost of replacing or rebuilding your property to the same or similar condition without a reduction for depreciation. Replacement Cost policies are more favorable to the insured homeowner, but the premiums are higher.
It should also be pointed out that regardless of which calculation method is used, you will have to pay your insurance deductible in the event of a claim.
What Risks Are Covered?
The extent of damages and losses that are covered by your policy will depend on whether you have an Open Peril policy or a Named Perils policy.
A Named Perils policy will name the specific risks (e.g. hail) that are covered by the policy, and any peril that is not listed will not be covered. Because Named Perils policies are not open-ended regarding covered risks, they are appropriate only for people that are concerned about specific risks.
Open Perils policies will provide coverage for all risks except those that are explicitly listed as not covered (e.g. earthquakes). An Open Perils policy is generally more expensive because it provides more comprehensive coverage.
What About Flood Damage?
Homeowner’s insurance policies normally do not cover flood damage. Unfortunately, many people are unaware that they need to buy a separate flood insurance policy to cover floods. According to Wikipedia, the “National Association of Insurance Commissioners (NAIC) found that 33 percent of U.S. heads of household still hold the false belief that flood damage is covered by a standard homeowners policy.”
The risk of flooding is typically limited to specific geographic areas, commonly called “flood zones.” Most people who are interested in buying flood insurance live (or have a second home) in or near a flood zone. Consequently, standard homeowner’s insurance companies view flood insurance as too financially risky to offer because they don’t have a broad enough population of flood insurance buyers to absorb the huge costs of repairing and rebuilding for flooded homes.
Fortunately, there are a few specialized insurance options for people who are concerned about the risk of flooding (and who don’t want to move to a lower risk location). The federal government created the National Flood Insurance Program (NFIP) to address the fact that most home insurers don’t offer coverage for floods. According to the above mentioned Wikipedia article, flood insurance “may be available for residents of approximately 19,000 communities nationwide through the NFIP.” You may also be able to buy specialized flood insurance from one of several private providers if you don’t want to buy insurance from NFIP (or if you don’t qualify for the program). A call to an independent insurance agent should help you find a good flood insurance policy for your home.
How Much Coverage Should You Buy And How Much Will It Cost?
There are many factors to consider when deciding on how much homeowner’s insurance coverage to buy. Homeowners should keep in mind not just the home’s purchase price, but all of the costs that would be incurred if the home needed to be replaced. You may want to hire a professional appraisers to determine the replacement cost.
If you upgrade your home or build an addition, you should update your policy limits to account for any increase in replacement cost. The same goes for personal property, which should be documented and inventoried to keep your policy up to date.
When determining the annual premium for a policy, insurance companies try to account for all of the risks that come with the specific homeowner and home. Insurers typically consider the homeowner’s income, occupation, sex, age, marital status, and credit score among other factors. With regard to the home itself, insurers often consider square footage, local building costs, types of building materials, crime rates in the community, and the likelihood of natural disasters in that geographic location.
The annual or monthly premiums for homeowner’s insurance can vary significantly between providers. It is worth the time to do some comparison shopping. In addition to price, homeowner’s should also compare insurance companies based on their reputation for customer service, speed of processing and paying claims, and creditworthiness.
Homeownership is rewarding but it would be very risky without homeowner’s insurance. When you purchase a good homeowner’s insurance policy, you can rest assured that you have taken the right steps protect your family, yourself, and your investment in a home.
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Enhanced Insurance is not written by attorneys. If you’re looking for legal advice, you need to contact a lawyer. Further, insurance practices and forms change constantly and are varied from state to state. For definitive answers in your area, contact a local agent.
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