Homeowners Insurance Guide: A Beginner's Overview

Homeowners insurance (also known as home insurance) is a necessity, not a luxury. Not just because it protects your home and belongings from damage or theft. Almost all mortgage companies require borrowers to have insurance coverage for the full or fair value of a property (usually the purchase price) and will not make a loan or finance a residential real estate transaction unless proof of coverage is provided.

You don't even have to own a home to need insurance; many landlords require renters to have renter's insurance. However, whether it is required or not, it is prudent to have this level of protection. We'll go over the fundamentals of homeowners insurance policies.

What a Homeowner's Policy Provides

A homeowner's insurance policy, while infinitely customizable, contains certain standard elements that specify what costs the insurer will cover.

Damage to the Interior or Exterior of Your House

In the event of damage caused by fire, hurricanes, lightning, vandalism, or other covered disasters, your insurer will compensate you so that your home can be repaired or rebuilt. Destruction or mutilation caused by floods, earthquakes, or poor home maintenance is typically not covered, and you may need to purchase separate riders if you want that type of coverage. Freestanding garages, sheds, and other structures on the property may also require separate coverage under the same guidelines as the main house.

Clothing, furniture, appliances, and the majority of your home's other contents are covered if they are destroyed in an insured disaster. You can even get "off-premises" coverage, which means you can file a claim for lost jewelry anywhere in the world. However, there may be a cap on how much your insurer will reimburse you. According to the Insurance Information Institute, most insurance companies will provide coverage for 50% to 70% of the amount of insurance you have on your home's structure. For example, if your house is insured for $200,000, your possessions are covered up to $140,000 in value.

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

Personal Liability for Damage or Injuries

Liability insurance protects you from third-party lawsuits. This clause extends to your pets as well! So, if your dog bites your neighbor, Doris, regardless of whether the bite happens at your house or hers, your insurer will cover her medical expenses. Alternatively, if your child breaks her Ming vase, you can file a claim to compensate 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 as well, just like if someone was injured on your property.

According to the Insurance Information Institute, while policies can provide as little as $100,000 in coverage, experts recommend having at least $300,000 in coverage. A few hundred dollars more in premiums can buy you an extra $1 million or more in coverage through an umbrella policy.

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

It's unlikely, but if you are forced to leave your home for an extended period of time, it will undoubtedly be the best insurance you have ever purchased. This section of insurance, known as additional living expenses, would reimburse you for rent, hotel rooms, restaurant meals, and other incidental costs incurred while waiting for your home to be habitable again. However, before booking a suite at the Ritz-Carlton and ordering caviar from room service, keep in mind that policies impose daily and total limits. Of course, if you're willing to pay more for coverage, you can increase those daily limits.

Different Types of Homeowners Coverage

Certainly, not all insurance is created equal. The cheapest homeowners insurance will almost certainly provide the least amount of coverage, and vice versa.

There are several types of homeowners insurance in the United States that have become industry standards; they are designated HO-1 through HO-8 and offer varying 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

After deducting depreciation, actual cash value covers the cost of the house plus the value of your belongings (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 depreciation, allowing you to repair or rebuild your home up to the original value.

Guaranteed (or extended) replacement cost/value

The most comprehensive, this inflation-protected policy pays for whatever it takes to repair or rebuild your home—even if the cost exceeds your policy limit. Certain insurers provide an extended replacement, which means it provides more coverage than you purchased, but there is a cap; typically, it is 20% to 25% higher than the limit.

Some advisors believe that all homeowners should purchase guaranteed replacement value policies because you need enough insurance to rebuild your home, preferably at current prices, not just enough insurance to cover the value of your home (which probably will have risen since you purchased or built). "Many shoppers make the mistake of insuring [a house] just enough to cover the mortgage, but that usually equates to 90 percent of your home's value," says Adam Johnson, product manager for policy comparison site QuoteWizard.com. "Because the market is volatile, 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 a cushion to the homeowner if construction prices rise.

What Isn't Covered by Homeowners Insurance?

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

What if you live in a flood-prone or hurricane-prone area? Or perhaps an earthquake-prone area? You'll need riders or an additional policy for earthquake or flood insurance. You can also add sewer and drain backup coverage, as well as identity recovery coverage, which reimburses you for expenses incurred as a result of identity theft.

How Are Homeowners Insurance Rates Determined?

So, what's the impetus behind rates? According to Noah J. Bank, a vice president and insurance advisor at HUB International, it's the insurer's perceived "risk" that a homeowner will file a claim. And, in determining risk, home insurance companies take into account the homeowner's previous home insurance claims, as well as claims related to that property and the homeowner's credit. "Claim frequency and severity of the claim play a significant role in determining rates, especially if there are multiple claims relating to the same issue, such as water damage, wind storms, and so on," says Bank.

While insurers are in business to pay claims, they are also in business to make money. Insuring a home that has had multiple claims in the last three to seven years, even if the claim was filed by a previous owner, can raise your home insurance premium to a higher pricing tier. According to the Bank, you may not even be eligible for home insurance based on the number of recent past claims filed.

The neighborhood, crime rate, and availability of building materials will all play a role in determining rates. Of course, coverage options such as deductibles or additional riders for art, wine, jewelry, and so on—as well as the amount of coverage desired—all contribute to the size of an annual premium.

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

What other factors influence your rates? "The condition of your home may also reduce the interest of a home insurance company in providing coverage," says Bill Van Jura, an insurance planning consultant in Poughkeepsie, N.Y. "A poorly maintained home increases the likelihood that the insurer will pay on a damage claim." Even the presence of a dog in your home can cause your home insurance rates to rise. Depending on the breed, some dogs can cause significant damage.

Cost-Cutting Insurance Tips

While it is never a good idea to skimp on coverage, there are ways to reduce insurance premiums.

Maintain a security system

A burglar alarm monitored by a central station or directly linked to a local police station can help reduce the homeowner's annual premiums by 5% or more. To qualify for the discount, the homeowner must typically provide proof of central monitoring to the insurance company in the form of a bill or a contract.

Another important consideration is the use of smoke alarms. Although they are standard in most modern homes, installing them in older homes can save the homeowner 10% or more on annual premiums. CO detectors, deadbolt locks, sprinkler systems, and, in some cases, weatherproofing can also be beneficial.

Raise your deductible

The higher the deductible, as with health insurance or car insurance, the lower the annual premiums. However, choosing a high deductible means that claims/problems that typically cost only a few hundred dollars to fix, such as broken windows or damaged sheetrock from a leaking pipe, will almost certainly be absorbed by the homeowner. And it's easy for these to add up.

Look for multiple policy discounts

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

Plan ahead for renovation

Consider the materials that will be used if you plan to build an addition or an adjacent structure to your home. Because wood-framed structures are highly flammable, they typically cost more to insure. Structures made of cement or steel, on the other hand, will be less expensive because they are less likely to be destroyed by fire or adverse weather conditions.

Another factor that most homeowners should consider, but often do not, is the insurance costs associated with building a swimming pool. In fact, items such as pools and/or other potentially hazardous devices (such as trampolines) can increase annual insurance costs by 10% or more.

Pay off your mortgage

Obviously, this is easier said than done, but homeowners who own their homes outright will most likely see a reduction in their premiums. Why? The insurance company believes that if you own a place completely, you will take better care of it.

Make regular policy reviews and comparisons

Whatever the initial price you're quoted, you should do some comparison shopping, including looking into group coverage options through credit or trade unions, employers, or association memberships. Even after purchasing a policy, investors should compare the costs of other insurance policies to their own at least once a year. In addition, they should review their current policy and make note of any changes that may have occurred that may have resulted in lower premiums.

Perhaps you dismantled the trampoline, paid off the mortgage, or installed a sophisticated sprinkler system. If this is the case, simply notifying the insurance company of the changes and providing proof in the form of photos and/or receipts could result in significant savings in insurance premiums. "Some companies have credits for complete plumbing, electric, heat, and roof upgrades," Van Jura says.

Make periodic assessments of your most valuable possessions to determine if you have enough coverage to replace them. "Many consumers are under-insured with the contents portion of their policy because they have not done a home inventory and added the total value to compare with what the policy is covering," says John Bodrozic, co-founder of HomeZada, a home maintenance app.

Look for changes in the neighborhood that may result in lower rates. Installing a fire hydrant within 100 feet of the home, for example, or erecting a fire substation near the property, may result in lower premiums.

How to Compare Home Insurance Companies

Here's a checklist of search and shopping tips for finding an insurance carrier.

1. Compare statewide costs and insurers

When it comes to insurance, you want to make sure you are dealing with a legitimate and creditworthy provider. Your first step should be to visit the website of your state's Department of Insurance to learn the rating for each home insurance company licensed to do business in your state, as well as any consumer complaints lodged against the insurance company. The website should also include an average cost of home insurance in various counties and cities.

2. Do a company health check

Examine the scores of the top credit agencies (such as A.M. Best, Moody's, J.D. Power, and Standard & Poor's) as well as the National Association of Insurance Commissioners and Weiss Research for the home insurance companies you're considering. These websites track consumer complaints against companies, as well as general customer feedback, claim processing, and other information. In some cases, these websites will also rate a home insurance company's financial health in order to determine whether the company will be able to pay out claims.

3. Look at claims response

Following a significant loss, the burden of paying for repairs out of pocket while waiting for reimbursement from your insurer may place your family in a difficult financial position. A number of insurers are outsourcing core functions, such as claim processing.

Before you buy a policy, find out whether your claims will be handled by licensed adjusters or third-party call centers. "Your agent should be able to provide feedback on his or her experience with a carrier as well as its market reputation," says Mark Galante, president of PURE Group of Insurance Companies' field operations. "Look for a carrier with a proven track record of fair, timely settlements, and make sure to understand your insurer's stance on holdback provisions, which are when an insurance company withholds a portion of their payment until a homeowner can prove that repairs were started."

4. Current Policyholder Satisfaction

Every company will claim to provide excellent claims service. However, cut through the noise by inquiring about the insurer's retention rate—that is, what percentage of policyholders renew each year—from your agent or a company representative. Many businesses report retention rates of between 80% and 90%. Annual reports, online reviews, and good old-fashioned testimonials from people you trust can also provide satisfaction information.

5. Get Multiple Quotes

"Obtaining multiple quotes is important when shopping for any type of insurance; however, it is especially important when shopping for homeowner's insurance because coverage needs can vary so greatly." "Eric Stauffer, former president of ExpertInsuranceReviews.com, agrees. "Comparing multiple companies will produce the best overall results."

How many quotations should you obtain? Five or so will give you a good idea of what people are offering and how much leverage you have in negotiations. However, before gathering quotes from other companies, request a price from insurers with whom you already have a relationship. As previously stated, in many cases, a carrier with whom you already do business (for your car, boat, etc.) may offer better rates because you are an existing customer.

Some businesses offer a special discount to seniors or people who work from home. The reasoning is that both of these groups are more likely to be on-premises, making the house less vulnerable to burglary.

6. Look beyond price

The annual premium is frequently what drives the decision to purchase a home insurance policy, but don't base your decision solely on price. "No two insurers use the same policy forms and endorsements, and policy wording can vary greatly," Bank says. "Even if you think you're comparing apples to apples, there's usually more to it, so compare coverages and limits."

7. Talk to a Real Person

Stauffer believes that going directly to the insurance companies or speaking with an independent agent who deals with multiple companies, rather than a traditional "captive" agent, is the best way to get quotes "A home insurance agent or financial planner who only works for one company. However, "a broker license to sell for multiple companies frequently attaches their own fees to policies and policy renewals." "This could cost hundreds of dollars more per year," he says.

Bank advises consumers to ask detailed questions about their options: "You want to consider different deductible scenarios to best weigh whether it makes sense to opt for a higher deductible and self-insure," he says.