What is homeowners insurance and what type of policy do you need?

A homeowners insurance policy can play a critical role in safeguarding one of your most valuable possessions. FG Trade/Getty Images

During the nationwide lockdowns spurred by the coronavirus pandemic, many of us have found that our homes have represented “safety” and “protection” more than ever before. But how do you make sure that your home itself is protected? That’s where homeowners insurance comes into play.

A homeowners insurance policy can play a critical role in safeguarding one of your most valuable possessions. And if you plan to take out a mortgage when buying your home, homeowners insurance will most likely be required by your lender. Here’s what homeowners insurance is, what it covers, and how it works.

What is homeowners insurance?

Homeowners insurance protects your home and possessions against damage or theft and can provide liability protection for accidents that occur at your home. There are four main elements of homeowners insurance policies:

  • Dwelling coverage: Covers the interior and exterior of the physical structure of your home
  • Personal property: Covers the furniture, appliances, electronics, or other possessions that are inside your home
  • Liability: Covers the personal property of guests who visit your home and potentially medical costs connected to any accident they may suffer while on your property.
  • Loss of use: Covers your cost of living and transportation expenses while your home is being repaired if it becomes unlivable.

Each of the elements shown above will be subject to coverage limits as defined by your policy. The higher the coverage limits, the higher you can also expect your annual premiums to be.

Each time you make a claim on your homeowners insurance policy, you’ll need to pay an out-of-pocket deductible before your insurance kicks in.

Raising your deductible could help to lower your premiums. But know that if you have a mortgage, your lender may have a maximum deductible that you won’t be allowed to exceed.

What homeowners insurance is not

Homeowners insurance is sometimes confused with mortgage insurance. But it’s important to understand that these are two completely unrelated forms of insurance.

Mortgage insurance protects your lender (not you) in the event that you default on your mortgage loan. If you put down less than 20% on your home, mortgage insurance will usually be required. However, mortgage insurance doesn’t provide you with any protection against home damage, so you’ll still need to purchase a homeowners insurance policy.

Homeowners insurance is also sometimes confused with a home warranty. Home warranties are optional contracts (not required by your mortgage lender) that can provide wear-and-tear coverage for some of your home’s systems and appliances.

While your homeowners insurance might replace your refrigerator if it was destroyed in a fire, it would not pay to replace a part that simply broke due to old age or a defective design. But a home warranty could cover this type of repair.

However, your home warranty would not pay to rebuild the physical structure of your home if it burned down in a fire. So while a home warranty could be worth considering as a supplement to homeowners insurance, it is not a replacement.

What type of homeowners insurance do you need?

There are a few different types of homeowners insurance to consider if you’re shopping for a policy. Here are four of the most common types of policies and what they cover.

HO1 coverage

This is the most basic type of homeowners insurance coverage that you can buy. An HO1 policy will only pay for damages caused by the following 10 events:

  • Fire and lightning
  • Windstorm and hail
  • Explosion
  • Riots and civil commotion
  • Aircraft
  • Vehicles
  • Smoke
  • Vandalism and malicious mischief
  • Theft
  • Volcanic eruptions

If your home is damaged or destroyed by any other perils than the ones exclusively listed above, it’s unlikely that an HO1 policy would cover the repair or replacement costs.

HO2 coverage

An HO2 policy covers each of the named perils listed above, plus six more:

  • Falling objects
  • Ice, snow, or sleet
  • Accidental discharge of water or steam
  • Tearing apart, cracking, burning, or bulging of home systems
  • Freezing of home systems
  • Damage from electrical current

In total, an HO2 policy covers 16 of the most common perils that cause home damage. However, HO2 policies won’t cover any of the countless other ways that your home could be harmed. For broader coverage, you’ll need an HO3 policy.

HO3 coverage

While HO1 and HO2 are called “named perils” policies, HO3 insurance is an “open perils” policy for your dwelling. With an open perils policy, any and all perils are covered except those that are specifically excluded.

“Acts of God,” and “acts of war” are commonly excluded perils. So that means floods and earthquakes will not typically be covered by your standard policy coverage. But if you live in an area prone to either of these natural disasters, you can usually add coverage for them with riders.

Because open perils dwelling coverage provides much stronger home protection than HO1 and HO2 policies, HO3 policies are often the minimum coverage that mortgage lenders will allow homeowners to buy. HO3 policies are also the most common type of home insurance purchased by single-family homeowners.

HO5 coverage

While HO3 coverage provides strong coverage for the physical structure of your home, it’s a bit lacking in personal property protection.

HO3 policies provide open perils coverage for your dwelling, but only named perils coverage for your property. And while most HO3 policies provide replacement coverage for your dwelling, they typically only provide actual cash value coverage for your possessions.

HO5 coverage is stronger in both of these areas, providing open perils and replacement coverage for your personal property. If you have a lot of valuable possessions, HO5 coverage could be worth considering. However, it should be noted that many insurers can offer extra personal property coverage on HO3 policies with endorsements.

Note that the coverage types listed above are the most common options for the typical homeowner. However, if you live in a condo, you’ll likely need HO6 coverage. And if you live in a very old home, you may need to buy HO8 coverage.

How much does homeowners insurance cost?

The cost of homeowners insurance varies based on a variety of factors such as:

  • Where you live (is your area prone to natural disasters?)
  • The age of your home
  • The estimated value of your home
  • The deductible you set
  • The type of coverage you choose
  • Your roof’s condition

The state you live in will have one of the biggest impacts on the price of your policy. If you live in an area that frequently deals with hurricanes, earthquakes, or tornadoes, it’s likely that your premiums will be higher than someone living in a state that has a lower natural disaster risk.

No matter where you live, you could save money on your homeowners insurance policy by shopping around. Be sure to get multiple quotes before choosing an insurer. Or you could use an online shopping tool like Policygenius to compare dozens of home insurers at once.

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