One of the biggest mistakes you can make when shopping for homeowners insurance is to assume that all policies work the same. Getting the right amount and type of coverage allows you to protect your home in a financially sound manner, while getting the wrong coverage can be costly. As you shop for your policy, here are the most important things to know about how homeowners insurance works.
In this article
How do homeowners insurance coverages work?
Home insurance is typically offered as a package of coverages that work together to provide financial protection for damage to your home and possessions, injuries or damage you may cause, and certain other expenses.
Policies for houses, townhomes and mobile homes:typically contain the following coverages:
- Dwelling: Damage to your home from a covered peril
- Other structures: Damage to structures not attached to your home
- Personal property: Theft or damage to your belongings from a covered peril
- Loss of use: Temporary living expenses or lost rent if a covered peril leaves your home uninhabitable
- Personal liability: Injuries or property damage you cause to other people or their property
- Guest medical payments: Medical treatment for a guest injured on your property, regardless of fault
Insurance for condominium and co-op units usually include all but the dwelling and other structures coverages, which are instead often offered as building property coverage.
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How homeowners insurance covers property damage
For your dwelling, other structures and personal property, home insurance covers damage from many, but not all, common mishaps and disasters, collectively known as perils.
The most common covered perils include fire, falling trees, burst pipes, theft and, in most parts of the country, wind, tornados and hailstorms. The most common exclusions include floods and earthquakes, which can each be covered by separate insurance.
Learn more about how homeowners insurance covers natural disasters.
How liability and medical payments work
The personal liability coverage included in standard homeowners insurance covers injuries and property damage you cause to other people. This can include injuries resulting from your neglect or inattention to a visitor on your property and injuries or damage you cause away from your home.
Guest medical is separate coverage that pays the initial medical bills of a guest injured on your property before fault is determined.
How do homeowners insurance deductibles and limits work?
Choosing the right deductibles and limits work to keep your policy affordable while also making sure you receive enough money to put your life back together after a claim.
Understanding your deductible
Your homeowners insurance deductible is the amount you pay to repair or replace your home or belongings before insurance funds kick in.
For example, if a kitchen fire causes $10,000 in damage and you have a $1,000 deductible, the insurance company covers $9,000.
In general, a higher deductible reduces your insurance rate, while a lower deductible reduces your out-of-pocket costs, if you ever have to file a claim.
Homeowners insurance deductibles typically only apply to dwelling and personal property coverage.
Selecting coverage limits
Your policy’s limits are the maximum amount of money the insurance company pays for each of your coverages.
For most mortgages, lenders require your dwelling limit to match your home’s replacement cost value, which is the cost of rebuilding your home to its current specifications. Insuring your home at its replacement value is also a good practice if you don’t have a mortgage or have a low loan balance.
Most insurance companies use software to estimate your home’s replacement cost value, based on details such as its square footage, foundation type and quality grade. You can find most of this information online by looking up your home on your county assessor’s website.
The rest of your coverages are typically offered in default amounts, but you can usually adjust them.
The best way to figure out how much personal property coverage you need is to create an itemized list of your possessions and add up their value. Your personal liability limit should, at minimum, match your net worth, including the value of your home.
Reducing the limits for one or more of the coverages on your home insurance policy typically reduces your rate. However, choosing limits that are too low may cost you big in the event of a claim.
For example, if you only have a $100,000 liability limit and are held responsible for $175,000 in medical treatment, therapy and lost wages for a worker injured on your property, the $75,000 shortfall comes out of your pocket.
Is homeowners insurance required?
There is generally no legal mandate to purchase homeowners insurance, but lenders typically require it for a mortgage.
Some community or homeowners associations also require homeowners insurance, regardless of your mortgage status.
If you apply for a mortgage for a home in a high-risk flood zone, your lender is likely to also require flood insurance.
If you’re not sure of your home’s flood risk, or the flood risk of a home you want to buy, you can find it online in the Flood Map Service Center on the Federal Emergency Management Agency (FEMA) website.
How do different types of homeowners insurance work?
Since the types of policy you choose impact your homeowners insurance rates and claims payouts, it’s important to understand how open-peril, named-peril, replacement-cost and actual-cash-value policies work.
Open-peril vs. named-peril insurance
Open-peril insurance works by protecting against anything not specifically excluded in the policy, while named-peril coverage protects against causes specifically named.
Although the list of named perils is usually long, open-peril coverage generally provides more coverage and costs more.
Replacement cost vs. actual cash value
The replacement cost value of any item is the price of replacing it with a new one of the same kind and quality, while an item’s actual cash value is its value after depreciation.
In general, replacement-cost coverage costs more than actual-cash-value policies, because it requires an insurance company to pay out more money in claims.
Which types of homeowners insurance are best?
In general, open peril and replacement cost are the best types of insurance to get for both your home and belongings, because they give you the most protection.
Standard homeowners insurance typically offers open-peril/replacement-cost coverage for your home and named-peril/actual-cash-value coverage for your belongings.
However, most insurance insurance companies offer alternatives to match your needs and budget.
For example, you can often pay extra to upgrade to open-peril/replacement-cost coverage for your personal property. On the flip side, you may save money by choosing a policy that only protects your home on a named-peril basis.
| Policy type | Dwelling | Personal property |
|---|---|---|
| Best (more expensive) | Open peril/replacement cost | Open peril/replacement cost |
| Standard | Open peril/replacement cost | Named peril/actual cash value |
| Reduced (less expensive) | Named peril/replacement cost | Named peril/actual cash value |
As you compare homeowners insurance quotes, make sure to account for the different types of coverage in each proposal.
For example, a policy offering replacement-cost coverage for your personal property may be a better deal if it costs the same, or just a little more, than others covering your belongings at actual cash value.
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How do home insurance exclusions and limitations work?
While homeowners insurance covers many things, it’s important to know how the most common home insurance exclusions and limitations work.
Excluded perils
Standard homeowners insurance typically excludes damage from floods, earthquakes and other earth movements, including sinkholes and landslides, as well as sewer and drain backups. However, you can typically purchase separate insurance policies to protect yourself from each of these perils.
In areas along the Gulf Coast and certain other coastal regions, homeowners insurance often also excludes damage from wind and hail. Windstorm insurance is sold separately in these regions.
A standard homeowners insurance policy typically excludes damage caused by a sewer or drain backup, including a reverse flow. However, most insurance companies offer a relatively inexpensive water-backup endorsement to protect against this risk.
Homeowners insurance limitations
Although homeowners insurance includes coverage for your belongings, a standard policy typically sets sublimits on the amount of coverage available for jewelry and other valuables.
The coverage on jewelry, for example, is usually capped at $1,500, and similar limits typically also apply to furs, fine art, silverware, camera equipment and certain other items.
The specific types of property subject to these sublimits vary slightly by insurance company. Most companies also offer a floater or endorsement you can purchase for extra protection for high-value items.
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