Insurance. Do your eyes glaze over just reading the word? It may not be the most thrilling subject, but it's essential for new homebuyers to understand the nuts and bolts of their homeowners insurance. Virtually all mortgage lenders require insurance coverage to protect their investment. If the house you live in is destroyed, the real owners - and in most cases, that's the bank - would suffer a huge monetary loss.

Tutorial: Introduction To Insurance

You don't even have to "own" your home to need homeowners insurance; many landlords require their tenants to have coverage. But whether it's required or not, it's smart to have this kind of protection anyway. We'll take it step by step as we walk you through the basics of this type of policy. (For a breakdown of basic insurance terminology, check out Understand Your Insurance Contract.)

What a Homeowners' Policy Provides
The elements of a standard homeowners' insurance policy provide that the insurer will cover costs related to:

  • 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 that your house can be repaired or even completely rebuilt. Damage that is the result of floods, earthquakes and poor home maintenance is generally not covered and you may require separate riders if want that type of protection. (To learn how to protect yourself and what financial documents you need in your emergency kit, see Preparing For Nature's Worst.)
  • Loss or damage to your personal belongings - 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, for example - no matter where in the world you lost it. There may be a limit on the amount your insurer will reimburse you. Even if your Rolex or mink coat is damaged at home, there will be a limit on the coverage for that, too - unless you purchase a separate "floater" policy that insures the item for its full appraised value.

    According to the Insurance Information Institute, most insurance companies will provide coverage for 50-70% of the amount of insurance you have on the structure of your home. If your house is insured for $200,000, there would be up to about $140,000 worth of coverage for your possessions - would this be enough for you? In order to answer this question, you would need to have a list of all your possessions and their value, also called a "home inventory".

  • Personal liability for damage or injuries caused by you or your family - This clause even includes your pets! So, if frisky Fido bites your neighbor Doris, no matter where the bite happens to occur, your insurer will pay her medical bills. Or, if Junior breaks her Oriental 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 the premises of your home or property. While policies start in the range of $100,000 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 premium may buy you an extra $1 million or more through "umbrella coverage". (For more insight, see It's Raining Lawsuits: Do You Need An Umbrella Policy?)
  • Hotel or house rental while your home is being rebuilt or repaired - It's unlikely you'll ever need this protection, but if you do find yourself in this situation, it will undoubtedly be the best coverage you ever purchased. If your house has been completely destroyed or is so damaged that it's uninhabitable, you may need to rent another house or live in a hotel until it's repaired or rebuilt. This portion of homeowners' coverage would reimburse you for the cost of rent, hotel, restaurant meals and other incidental costs because you were unable to live in your house. 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 - but, of course, you can expand those daily limits if you're willing to pay more in coverage.

Different Types of 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.

There are essentially three levels of coverage:

  • Actual cash value - This value covers 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 - This is the actual cash value 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 - The most comprehensive, this inflation-buffer pays for whatever it costs to repair or build your home - even if it's more than your policy limit! Certain insurers offer extended replacement, meaning it offers more coverage than you purchased, but there is a ceiling; typically, it is 20-25% higher than the limit.

How Much Does It Cost?
The average yearly premium cost for U.S. homeowners insurance in 2008 (as of 2010, the latest year for which data is available) was $791, according the National Association of Insurance Commissioners, but premiums vary widely and depend on multiple factors. First, of course, price will be determined by how much coverage you buy, a decision you can only make after evaluating the market value of your house, completing a household inventory, and deciding how much liability protection you want.

Other variables that need to be considered include your zip code. If you live in a high-crime area, for example, insurance premiums will be higher. Companies also take into account the size of your house, how close it is to a fire hydrant, the condition of your plumbing, heating and electrical systems, how many claims were filed against the home you're seeking to insure, and even details like your credit score that reflect on how responsible a consumer - and, therefore, a homeowner - you are. (If you're worried you won't measure up, read Five Keys To Unlocking A Better Credit Score.)

No matter what initial price you're quoted, you'll want to do a little comparison shopping. And don't forget there are many other ways to slash costs, such as raising deductible levels, buying multiple policies from the same insurer, getting all available discounts (for security devices, such as burglar alarms, for example), checking for group coverage options through credit or trade unions, employers, or association memberships, and boosting your credit score. (To learn more ways to reduce premiums, see Insurance Tips For Homeowners.)

Selecting an Insurance Company
Price is important, but it is not the only or even the most important factor. When it comes to insurance, you want to make sure you are going with a provider that is legitimate and creditworthy. Before you sign on the dotted line, first contact your state's insurance department to make sure the company is licensed, as all insurers are required to be. Second, check its financial strength by going to websites of the top credit agencies (ex. A.M.Best, Moody's, Standard & Poor's) and searching their financials. Finally, consider asking relatives, friends and coworkers for referrals. It always makes sense to benefit from the experiences of others, so ask someone you know who has filed a claim about an insurer's customer service representatives, the speed with which a claim was appraised, processed and paid, in addition to your friend's general level of satisfaction with the insurer.

Conclusion
As with all insurance policies, they are under-appreciated until they are needed, and then they quickly become a godsend. Getting yourself set up with a comprehensive homeowners policy can go a long way toward making your home truly a place of comfort and security.

For a breakdown of other crucial coverage, check out Five Insurance Policies Everyone Should Have and Fifteen Insurance Policies You Don't Need.

Related Articles
  1. Your Practice

    Advisors: Win Over Millennials with Insurance

    Millennials don’t have the same values and goals as previous generations. Here are some tips on how advisors can adapt to their needs and wants.
  2. Home & Auto

    The Pros and Cons of Buying Vs. Building a Home

    Before you decide whether to buy or build a home, you should weigh the advantages and disadvantages of each scenario.
  3. Insurance

    Getting Your (Insurance) House in Order

    From starting a family to retirement, insurance can play a role in taking care of financial needs. This piece looks at some of the choices you can make.
  4. Home & Auto

    6 Reasons To Avoid Private Mortgage Insurance

    Homebuyers who put less than 20% down will likely be forced to secure private mortgage insurance. Here are six reasons to avoid it.
  5. Real Estate

    Ultra-Luxury Real Estate: What's Hot, What's Not

    And is this a good time to buy? Here's the 2016 forecast for luxury residences in seven global markets, from Shanghai to London to New York City.
  6. Real Estate

    You'll Need to Shell Out More for a Mansion

    But not everywhere. The places prices are still booming are ultra-luxe enclaves, such as Beverly Hills and the Hamptons.
  7. Insurance

    How High-Deductible Health Plans Work

    It will give you access to a Health Savings Account, but are the limitations worth the benefits?
  8. Real Estate

    The 5 Best Real Estate Lawyers in Los Angeles

    Discover some of the top real estate lawyers practicing in the Los Angeles area, and learn more about the kinds of legal issues they handle.
  9. Insurance

    Cashing In Your Life Insurance

    In tough economic times, tapping into a life insurance policy can provide a needed source of funds.
  10. Insurance

    Which Life Insurance is Right For You?

    Consumers have choices when it comes to life insurance. Knowing your future needs for cash or retirement can make the difference in what you select.
RELATED FAQS
  1. Who are the best-rated home insurance companies in the US?

    Based on consumer surveys, the best company for homeowners insurance in 2014 is Amica Mutual. Present and past insurance ... Read Full Answer >>
  2. What's the difference between Social Security Disability Insurance (SSDI) and Supplemental ...

    Disabled persons can receive payments through two programs: Social Security Disability Insurance and Supplemental Security ... Read Full Answer >>
  3. Do FHA loans require escrow accounts?

    Federal Housing Administration (FHA) loans require escrow accounts for property taxes, homeowners insurance and mortgage ... Read Full Answer >>
  4. Do FHA loans have private mortgage insurance (PMI)?

    he When you make a down payment from 3 to 20% of the value of your home and take out a Federal Housing Administration (FHA) ... Read Full Answer >>
  5. Does renters insurance cover water damage?

    An all-perils renters insurance policy does cover water damage, less the deductible, to personal property if the damage is ... Read Full Answer >>
  6. Does renters insurance cover storage units?

    An all-perils renters insurance policy provides coverage for the contents of storage units. Most policies limit the amount ... Read Full Answer >>
Trading Center