What you need to know about homeowners insurance

Homeowners Insurance Basics

by Gary Foreman

What is homeowners insurance?

Homeowners insurance is a contract between the owner of the home and the insurance company. The homeowner agrees to pay a set premium for coverage against specific types of losses. The insurance company agrees to pay for losses caused by specific events.

Typically damages to the house itself and its contents are covered in the policy. Some unusual contents (like fine art, jewelry, expensive collectibles or antiques, etc.) are excluded from normal coverage and require a "rider."

Homeowners insurance also covers liability issues that might arise due to accidents that happen on the property.

Homeowners Insurance Basics

How does a deductible work on home insurance?

Before the insurance company will pay for a loss, something called a "deductible" must be met. That's the amount the homeowner must pay himself. For example, if the policy calls for a $1,000 deductible and there's a $4,000 loss, the homeowner would pay the first $1,000 and the insurance company would pay the remaining $3,000.

The deductible is not paid to the insurance company. In most cases, a check for the deductible is never issued. It's just the amount that the homeowner must come up with on his/her own.

What needs to be covered by homeowners insurance?

Property andliability need to be covered against specific "perils." You're insuring againstloss of property and against harm done to others while on your property.

The property typically includes your physical home and outbuildings (sheds and garages) and the property within them (excluding certain items/collections/valuables).

The perils are typically fire, theft, vandalism, hail, and lightning. Generally floods and earthquakes are excluded but may be covered under separate policies.

Homeowners insurance package policy

Most homeowners insurance policies are "package" policies. They cover both property and liability.

Coverage for the home itself

The insurance policy will pay to repair or rebuild a home that's destroyed by fire, hurricane, lightning, or other disaster included in the policy. It generally will not cover damage caused by normal wear and tear, earthquake, or flood. Often outbuildings (gazebo, greenhouse, garden shed, and garage) are also covered.

Coverage for personal belongings

Furniture and most personal possessions are covered if loss is due to theft, fire, or other covered peril. Standard policies limit the amount to a percentage of the value of the building. Often possessions are also covered while away from the home (for instance items taken with you on vacation). Expensive items (jewelry, silverware, and antiques) are covered with a limit.

Landscaping is also covered at usually up to $500 per item. Coverage is for theft, fire, and lightning but not for wind or disease.

Liability coverage

Liability covers the insured (and their family members and pets) for personal injury or property damage that they cause to other people. Both the cost of defending against a lawsuit and any damages awarded are covered up to the policy limits. Some homeowners choose to buy an additional "umbrella or excess liability" policy to provide additional coverage.

Additional living expenses

If your home is inhabitable do to an insured disaster, the insured will be covered for hotel, restaurant meals, and other living expenses until they can return home.

Your type of home

If you own your home, the most common policy is HO-3. It provides coverage for the home structure, personal belongings, and liability. It also covers damage caused by riot, aircraft, vehicles, smoke, and other perils.

If you own a multifamily home, the most common policy is an HO-3 with an endorsement for risks associated with renters.

If you own a mobile home, the most common policy is an HO-2.

If you're a renter, you'll want an HO-4 policy. It covers the insured's possessions against the same losses as HO-3 and also provides third party liability coverage.

Condominium and co-op owners will need an HO-6 policy. It provides structural coverage for the building portion that the policyholder owns. It also provides coverage for the possessions like an HO-3 policy and liability coverage and also additional living expenses.

Related: Why You Need a Home Inventory

How much will you receive?

Most policies cover items on an "actual cash value" basis. That means that they will pay you what you could get for a lost item if it had been sold. For example, a two-year-old TV might be worth $50 or $75.

"Replacement Cost" coverage pays you to repair, rebuild, or replace losses without any deduction for depreciation.

"Guaranteed/Extended Replacement Cost" coverage pays the amount necessary to rebuild a home as it was prior to the loss, even if that amount is greater than the policy limit. It excludes upgrades required by new building codes. That requires an "Ordinance Law" policy.

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Gary Foreman

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter. Gary is also available for audio, video or print interviews. For more info see his media page.

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