What is Homeowners Insurance?

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Definition:

Homeowners insurance is a type of insurance that covers the cost of damages to an individual’s home and belongings.

🤔 Understanding homeowners insurance

As much as we like to view homes as safe and protective places, there’s always a risk that an unexpected event, like a hurricane, tornado, or fire, could damage or destroy them and the belongings they house. Most homeowners don’t have the financial means to pay for those damages out of pocket and quickly recover from the loss. Homeowners insurance provides a way to reduce these financial risks and ensure that no matter what happens to one’s home, a policyholder will be able to pay for the damages or buy a new home without putting their finances on the chopping block. Homeowners insurance can also protect against other costs the policyholder may incur, such as if someone gets injured on their property.

Example

Let’s imagine there’s a homeowner, Ron, who has a homeowners insurance policy with a $2,000 deductible. One day, a fire causes $70,000 worth of damage to Ron’s home. Ron calls up his insurance agent to file a claim, and after investigating, his insurer agrees it’s a covered loss and pays the cost of the damages. Ron pays his $2,000 deductible out of pocket, and his insurance company covers the remaining $68,000. Now, Ron is able to pay for the necessary repairs without putting a major dent in his bank account. Plus, since his policy covers loss of use, Ron’s insurer pays for him to stay somewhere else while the house is being repaired.

Takeaway

Homeowners insurance is like a shield for your money . . .

If you have a homeowners insurance policy, and something happens to your house, you generally won’t have to pay for the damages yourself, and your finances won’t take a major hit. You’ll have to pay to purchase the policy, and you’ll typically need to pay a portion of the damages yourself, but your insurance policy will protect your bank account from any serious damage.

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What is Homeowners Insurance?

A typical homeowners insurance policy provides the policyholder with two different types of insurance:

  • Property damage insurance: Homeowners insurance covers your personal property (your home and the personal belongings it houses) against damage from certain events, such as fires, windstorms, and vandalism. The specific events covered vary from policy to policy. If your insurance company deems the damage to be a covered loss (covered by your policy), it will pay the repair or replacement costs. Many homeowners policies also include loss of use coverage, which means that your insurer will pay for alternative housing while your home is repaired or replaced.
  • Personal liability insurance: If someone is injured on your property, your insurer will cover the cost of your legal fees as well as the third-party’s medical payments, funeral costs, and repair or replacement costs.

At the end of the day, homeowners insurance is a form of financial protection. If something happens to your home, or someone is hurt at your home or property, your homeowners policy will pay up so you don’t have to — Assuming the damage is covered under your individual policy’s terms, of course.

What does homeowners insurance cover?

To figure out what a homeowners insurance policy covers, you need to ask two questions: what and how much? Every policy will have different covered losses (what) and different coverage limits (how much).

Let’s start with what homeowners insurance covers. Most standard policies cover losses from the following events or perils:

  • Fires
  • Vandalism
  • Windstorms
  • Aircraft
  • Riots or other civil disturbances
  • Explosions
  • Theft
  • Volcanic eruption
  • Lightning
  • Smoke
  • Vehicles

If you’d like more coverage, you can look into purchasing a broad-form policy, which typically covers the following perils:

  • Weight of snow, ice, and sleet
  • Accidental damage from:
  • Water
  • Steam
  • Household appliances
  • Sprinklers
  • Heating
  • Air conditioning
  • Plumbing
  • Electrical currents

You may notice that basic and broad-form policies both don’t typically cover losses from the following perils:

  • Flooding
  • Earthquakes
  • Neglect
  • War
  • Power failure
  • Intentional loss

If you want to stay covered against those perils, you’ll usually need to purchase an extra policy that specifically covers those events, such as flood insurance, earthquake insurance, etc.

Alternatively, you can purchase an open-peril policy, which covers all losses except those caused by specifically excluded perils. Exclusions vary from policy to policy, so some may cover earthquakes, neglect, and war, but others may not.

Now, let’s take a look at how much a homeowners insurance policy covers. There are two factors that affect how much a policy will cover: the deductible and the coverage limits.

  • Deductible: The deductible is the amount of money you need to pay out of pocket when your insurer covers a loss — Think of it like a deductible for your health insurance. If you have a $1,000 deductible, for example, and you file a claim for $10,000 worth of vandalism damage, you’ll need to pay the $1,000 deductible, and your insurer will cover the remaining $9,000.
  • Coverage limits: Homeowners insurance policies set a maximum amount that the insurer will pay for damages. So, if you purchase a policy with a $200,000 liability coverage limit, and you suffer $300,000 worth of damage, you’ll be on the hook for the remaining $100,000.

A base homeowners insurance policies cover the cost of replacing your home’s structure and the actual cash value of your personal property. The actual cash value is typically the property’s initial market value minus the depreciation. Usually the homeowner will enhance this coverage since does not cover replacement value and can leave you underinsured.

If you’re purchasing homeowners insurance, you’ll need to determine for yourself how much coverage you need. Just keep in mind that the higher your policy limits and lower your deductible, the more you’ll need to pay each month for your policy.

Why do you need homeowners insurance?

There are two reasons that most people need homeowners insurance: for personal financial protection and because their mortgage lender requires it.

For most people, a burned down house means more than heartache and the loss of their home: it also means a significant hit to their net worth. A home is a huge financial asset, so if it goes up in flames, that can seriously threaten the owner’s financial footing. A homeowners insurance policy protects a homeowner so that even if their home burns to the ground, their finances don’t go down with it.

But there’s another piece of the puzzle: Most homeowners don’t own their homes outright. Instead, they get a home loan, sign a mortgage contract, and pay off their debt over time. As collateral, the lender receives the right to sell the house if the borrower doesn’t pay back their loan on time.

But what happens if the house is destroyed in a fire before it’s fully paid off? Suddenly, the lender’s collateral is gone or severely impaired, and the borrower has to pay off a loan for a house that may not exist. To protect against this, many lenders require borrowers to have a homeowners insurance policy. And many require that homeowner premiums be included in the mortgage payments

Why is a homeowners insurance policy considered a package policy?

A homeowners insurance policy is considered a package policy because it’s made up of two distinct types of insurance: property damage insurance and liability insurance.

When you purchase a homeowners insurance policy, your insurance agent offers you both of these policies and wraps them up in a singular package for you.

What is the difference between homeowners insurance and other types of insurance?

There are several types of home insurance policies that are commonly confused with homeowners insurance:

-Homeowners insurance vs. home warranty: Homeowners insurance protects the policyholder against losses caused by catastrophic events like fires, natural disasters, or vandalism. A home warranty, on the other hand, simply covers the cost of repairs to a home’s systems and appliances due to aging and normal wear and tear.

  • Homeowners insurance vs. mortgage insurance: Mortgage insurance doesn’t cover losses caused by physical damage of any kind. Instead, it only covers the lender if the borrower defaults on their mortgage and can’t pay it back.
  • Homeowners insurance vs. hazard insurance: Hazard insurance is part of a homeowners insurance policy — It covers damage from hazards like fires, lightning, and windstorms. Homeowners insurance, on the other hand, is a package policy that bundles hazard insurance, other forms of property damage insurance, and personal liability insurance in a singular policy.

What are the types of homeowners insurance policies?

There are eight types of homeowners insurance policies in the US:

HO-1 (basic form): An HO-1 policy covers your house against the following perils:

  • Fires
  • Vandalism
  • Windstorms
  • Aircrafts
  • Riots or other civil disturbances
  • Explosions
  • Theft
  • Volcanic eruption
  • Lightning
  • Smoke
  • VehiclesHO-2 (broad form): An HO-2 policy covers everything in an HO-1 policy, plus:
  • Falling objects
  • Freezing of plumbing, AC, or other systems
  • Weight of ice, snow, or sleet
  • Sudden cracking, bulging, or breakdown of internal systems
  • Water damage or steam damage from overflow
  • Damage from electrical current

HO-3 (special form): An HO-3 policy is an open-peril policy that covers all perils except those specifically stated as not covered by the policy. An HO-3 policy also typically covers attached structures like garages and tool sheds.

HO-4 (tenants form): This type of policy is more commonly known as renters insurance. It only covers personal liability and the loss of personal belongings.

HO-5 (comprehensive form): HO-5 policies expand the open-peril coverage of an HO-3 policy by excluding fewer perils. The specific exclusions will vary from policy to policy, but typical exclusions include losses from:

  • Earthquakes
  • Floods
  • War
  • Mold
  • Water damage
  • Pets
  • Neglect
  • Wear and tear
  • Corrosion and rust
  • Infestations
  • Laws

HO-6 (condo form): HO-6 policies are specifically designed for condo owners and cover personal liability and losses to personal belongings. Most HO-6 policies also cover the ceilings, walls, and floors of the condo.

HO-7 (mobile home form): Normal homeowners insurance policies do not cover mobile and manufactured homes, so HO-7 policies fill that gap.

HO-8 (older home form): An HO-8 policy is basically the same as an HO-3 policy, but it has small tweaks that provide better coverage for the unique needs of an aging or historical home.

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