Reader question: “We are shopping for a homeowners policy. This is our first time buying a house, so we are ‘newbies’ when it comes to home insurance coverage. I’m confused about what home insurance covers, and what it doesn’t cover. I’ve been researching this topic online, but I’m still not clear on it. Can you explain the basic type of coverage please?”
I can understand your confusion, and I assure you that you’re not alone. We get a lot of questions on this subject, and most of them come from first-time buyers like yourself. But don’t worry. By the time you finish reading this article, you’ll know what a basic home insurance policy covers.
4 Common Areas of Home Insurance Coverage
A basic homeowners policy can be broken down into four areas of coverage:
- Coverage for the house itself (the structure).
- Coverage for the items within the house (your belongings).
- Liability protection for accidents that occur on your property.
- Additional living expenses, for occasions when you are unable to live in your house.
We will talk about each of these items in turn. When shopping for a home insurance policy, it’s important that you understand the different types of coverage. You can’t compare one policy to another until you understand the following components.
1. The structure of your home
This is the most important part of your home insurance policy, because it covers the house itself. This coverage will pay and/or reimburse you for the cost of restoring your home, if it’s damaged by fire, lightning, hurricane, hail, etc. You’ll have to refer to your particular policy to find out what types of disasters it covers.
HO-2 and HO-3 are the two most common policies for residential structures. This level of home insurance will cover the “16 perils.” These perils include (but are not limited to) fire, lightning, falling objects, smoke damage, explosions, theft, vandalism and bursting pipes. HO-6 is similar, but it’s used for co-ops or condominiums.
Just bear in mind that most homeowners policies do not cover floods and earthquakes. You’ll probably need to purchase extra coverage for those events, if you live in an area that’s prone to them.
When shopping for a policy, it’s vital that you buy enough coverage to rebuild the home in the event that it is totally destroyed. This is arguably the most important factor when buying insurance.
Basic home insurance will also cover attached structures, such as your garage or shed. But these structures are usually covered for a lower percentage than the home itself. Just be sure to ask about this when reviewing policies, and read the fine print found within the policy itself. Don’t purchase until you know what you’re getting.
2. Personal property and belongings
A standard home insurance policy will also cover your belongings, up the amount stated in the policy. This includes your furniture, electronics, clothing and other personal property kept within the house. This covers losses and damages to personal property resulting from hurricane, fire, or any other items included in your home insurance policy.
You can tailor the amount of coverage you want for your belongings. Insurance companies will typically cover these items 50% – 70% of the structural coverage. For example, if you have $100,000 worth of coverage for the house itself, you would have $50K – $70K worth of coverage for your belongings.
It’s a good idea to itemize the cost of all items within your home. This will help you determine how much protection you need from your home insurance policy.
You will probably be given an option to choose between “replacement cost” coverage, and “actual cash value.” Here’s the primary difference between them:
But the amount of property coverage will vary based on the terms of your policy. You will either choose cash value or replacement cost. Here’s the difference between them:
- Cash value — With this type of coverage, your belongings are only covered up to the amount you paid when you first purchased them. Let’s use a TV set as an example. If you had some kind of property damage that took out your ten-year-old television, the insurance company would only cover it for the amount you paid ten years ago. But this amount might be much less than the current price of a TV.
- Replacement cost — This is the alternative to cash-value coverage, described above. With this coverage, lost or damaged item is replaced at the full and current cost. Remember the ten-year-old TV we talked about above? This time around, the insurance company will replace the TV with a current set, even if it costs more than what you paid ten years ago.
In short, replacement cost will give you more coverage than cash value. But you’ll pay more for the extra protection. There is a seesaw relationship between coverage and cost.
You should also pay close attention to any dollar limits in this section of your policy. For example, your home insurance may only cover expensive items like jewelry up to a certain dollar amount. This kind of restriction is fairly common in homeowners policies.
3. Liability coverage
If somebody gets hurt on your property, you could be liable for any medical costs resulting from those injuries. Liability coverage is the part of your home insurance that covers you from such losses. It may even include damages caused by your pets (if the policy is set up that way). Liability coverage typically pays for your legal costs as well as any court judgments, up to the amount specified in your home insurance policy. Depending on your coverage plan, you might be covered outside of the home as well — anywhere you go.
4. Additional living expenses
This is another important part of your home insurance policy and protection. It covers the cost of living away from home, if your home is unlivable due to fire damage or other insured disasters. Depending on the policy, it might cover everything from hotel bills to restaurant tabs, while you’re waiting for the home to be repaired.
This part of the policy will vary from one insurance company to the next. Some companies cover you for a flat percentage, such as 20% of the insurance on your home. Other companies allow you to purchased unlimited coverage for living expenses, but only for a certain amount of time. Think about your emergency plans for such scenarios, and choose the home insurance policy that best supports those plans.
Read the Fine Print to See What It Covers
As far as coverage is concerned, it doesn’t matter what your insurance agent tells you. The only thing that matters is what you have in writing. So read every single paragraph of your homeowners policy, before you make purchasing decision. Read the fine print. It will spell out exactly what your home insurance covers, and what it doesn’t. Go through it with a yellow highlighter, if you have to. Mark anything you don’t understand, and then ask your agent about it.
Home insurance policies are fairly straightforward, once you understand the key concepts explained above. But they do contain a lot of confusing jargon. So ask your agent what your home insurance will cover, and how much you will pay for that coverage.