Homeowners Insurance Explained

Becoming a homeowner means taking on some new, serious, and sometimes frightening responsibilities. Getting a mortgage and buying a home is quite possibly the largest investment you will make in your lifetime.

Sure, a piece of land and real estate to call your own may be well worth the investment, but the costs and responsibilities don’t stop at a monthly principal and interest payment.

Judging by the sheer number of people who choose to rent rather than buy, it is safe to assume that plenty of people can agree that homes are expensive. Homeowners, on the other hand, can tell you that it isn’t just the cost of the home that is of any importance -- it is everything you put into that home and everything that the home represents to a homeowner and their family. Knowing that sometimes life can throw a curve ball and take all of that away is more than just a scary thought.

And we know that while properties can be repaired or replaced, a true home is irreplaceable. A little peace of mind can go a long way. All parties involved in a mortgage can agree to that.

This is what makes homeowners insurance such an important and required part of being a homeowner. Homeowners insurance is the peace of mind for the homeowner who has put their blood, sweat, tears, and hard-earned money into a property to make it into a home. It is also a breath of relief for the lenders who rely on the well being of a property that is used as collateral on a loan as large as the average mortgage.

Homeowner’s Insurance also makes up part of the last component in the calculation of PITI (principal, interest, taxes, and insurance) when determining a homeowner’s monthly mortgage payments.

What Is Homeowners Insurance?

Homeowner’s insurance is a type of insurance policy that covers a property owner in the event of losses or damages to the individual’s home and assets within the home. It also functions as liability coverage in the event of accidents that take place in the home or on the property. Besides providing the aforementioned peace of mind, homeowner’s insurance is the coverage a homeowner needs, and a lender requires.

The first thing a home buyer should understand about homeowner’s insurance is that it exists in many forms, but is a mandatory part of any mortgage agreement. There are various forms of homeowner’s insurance and even policies that provide coverage for renters. Some types of homeowner's insurance only apply to specific areas that are prone to a certain type of natural disaster, such as floods or earthquakes.

A standard homeowner’s insurance policy provides financial coverage for losses or damages caused by theft, accidents, and some natural disasters such as fires. The typical policy is actually slightly more complex, as it is broken up into four areas of protection.

The four areas protected under the standard homeowner’s insurance policy are structural coverage, coverage for personal belongings, liability protection, and additional living expenses or “ALE”.

Each of these sections represents a pillar of what is covered under the standard homeowner’s insurance policy. Understanding what exactly is covered in each pillar will help paint a clearer picture of just how important a good insurance policy can be for any homeowner. Here’s the breakdown of each section:

Structural Coverage

Arguably, this is the most obvious section in terms of what people typically think about when it comes to homeowner’s insurance. Still, it is probably the most important, since it deals with coverage for the actual property, which is usually the most expensive asset an individual owns. Structural coverage, by that argument, is the basis for homeowner’s insurance in general and is the portion that lenders care about the most.

Coverage for the structure of your home provides financial protection should your house or property require repair or rebuilding after sustaining damage or being destroyed by fire, hurricane, lightning, hail or any other disasters listed in your policy.

The standard policy will not cover flood damage, earthquake damage, or normal wear and tear any structure generally faces. Detached structures on the property such as garages, gazebos, and tool sheds are also typically covered by the standard policy.

Policies are generally offered with different amounts designated towards structural coverage. The coverage a home buyer chooses should be seriously considered, as it may be the only thing standing between a homeowner and financial ruin. It’s highly recommended that the coverage amount chosen should be able to cover rebuilding the home in the worst case scenario.

Coverage for Personal Belongings

As we have mentioned earlier, a home is more than just a structure, it is also everything inside of it that makes it what it is. Homeowners tend to keep a good portion of their assets and most valuable possession inside of their homes. In the case of a disaster or even theft, these personal belongings are typically covered under the standard homeowner’s insurance policy to some extent.

Homeowners can count on a good portion of their homeowner’s insurance policy to cover loss, theft, or damages to their belongings. Items like furniture, appliances, electronics, housewares, and even clothing (to name a few) are eligible for coverage. These items and other personal belongings are insured against theft or damage from any listed disasters on the policy for anywhere between 50 - 70% of the amount the structure is insured for.

Interestingly, the coverage even extends to personal belongings stored off-site. That means that items kept in storage units or anywhere else in the world can be covered by your homeowner’s insurance policy. Even more interesting, many policies contain coverage for up to $500 towards the unauthorized use of a credit card.

For more expensive items such as art, collector’s items, or jewelry it is often necessary for a homeowner to purchase additional insurance. The standard homeowner’s insurance policy generally places a dollar limit on the replacement or repair of such items, so they may lack the appropriate coverage. To insure these items at full value, a homeowner will need to purchase a special personal property endorsement or floater after having the item or items officially appraised.

Before deciding on any particular homeowner’s insurance policy, it is in good practice for a homeowner to conduct a thorough home inventory. It can be quite a tedious task, but going through the process of cataloging each item, with detailed descriptions, serial numbers, and prices is the only way to determine whether or not you have enough coverage. In addition, this list acts as a kind of proof for the insurance company to pay out the appropriate amount of coverage towards these items.

In addition to personal property, the landscaping usually also falls under the protection of the standard insurance policy. Trees, shrubs, and even the most exotic plants are covered. The average homeowner’s insurance policy covers these for up to $500 per item.

Liability Protection

No matter where you or your property is located, and no matter how much precaution is taken, accidents happen. Should an accident that harms another individual or their belongings occur either on your property or by you, your family, or your pets, you will need some financial protection in place to keep you out of debt.

Luckily, liability protection is a pillar of the standard homeowner’s insurance policy.

Most commonly, liability protection is associated with no fault medical coverage for any bodily injury sustained on a homeowner’s property. This type of protection covers any costs associated with any damages to another individual on your property due to negligence. Some typical costs that are covered include medical bills, loss of income, pain and suffering, and should also cover your legal defense costs in the event of a dispute, as well as any court-ordered awards.

Some policies also include coverage for damages caused by you, your family, or your pets on another individual’s property or to an individual’s personal belongings. This is important as some accidents may occur outside of your home, by you, your family or even your pets.

So if you send your children to stay with a family friend and they happen to break an expensive vase while playing a game of tag, your policy can cover the costs, and save you from emptying your bank account.

The limits for liability coverage typically start at $100,000. Keeping in mind that it is also the coverage for legal fees and any payouts that must be made as ordered in a court of law, increasing this limit might just be well worth the cost. After all, a strong lawsuit can be enough to bankrupt even the wealthiest of people. While taking the necessary precautions to ensure that accidents that could cause a guest any bodily harm don’t happen, good liability protection is still never a waste of money.

In order to increase liability protection, a homeowner would have to discuss it with their homeowner’s insurance provider. Larger limits are typically available, and homeowners can purchase an umbrella policy, which provides additional coverage beyond what is covered in the original policy.

This excess liability coverage not only has a higher limit of protection but also broader coverage, sometimes including such acts as slander or libel. Be aware though, purchasing umbrella coverage is usually only available after purchasing the maximum liability protection limit on your insurance policy.

Additional Living Expenses

In a worst case scenario, you may not be able to continue inhabiting your home, at least until it has been sufficiently repaired or rebuilt. This period of time can be an absolute nightmare for any homeowner and their family. Especially if they don’t have anywhere to stay while waiting to reoccupy a home or find a new home.

For this exact reason, a good portion of homeowner’s insurance policies have additional living expenses as part of the coverage. Additional living expenses coverage (ALE), sometimes referred to as “loss of use coverage”, is meant to provide financial coverage for any costs of living away from the property while it is being repaired or rebuilt due to damage sustained by an insured disaster. Sometimes, a family can be displaced for long periods of time after a natural disaster, and this coverage definitely softens the financial blow.

Additional Living Expense coverage pays the costs of hotel bills, restaurant meals, and other costs associated with living away from home. Even the most basic of policies provides more than adequate limits to this coverage, extending well past a homeowner’s typical cost of living. Though there are some limitations.

Typically, insurance providers put time limitations on additional living expense coverage. Discussing the limits in place before settling on a policy is important, as you never know how long you might have to be away from your home. Even with repairs, there can be unforeseen circumstances that extend the time it takes to complete a project, and without enough coverage, a homeowner may have to start forking out his or her own money to cover the ALE costs.

For homeowners who rent out a portion of their homes, loss of use coverage typically pays for that rent that you would have collected from your tenant during the time frame of not being able to inhabit the property as well. This can be a saving grace for many homeowners with tenants, as many of them rely on the rent paid to help with the overall cost of their mortgage. The last thing a homeowner needs after suffering losses or damages to their property is a looming risk of foreclosure.

While all of the coverage provided for additional living expenses sounds too good to be true, it is absolutely true, and then some. Note that even with limits in place, the coverage for loss of use in no way interferes with the coverage allocated to repairing or rebuilding your home. That definitely counts toward peace of mind!

Disaster Insurance

Some properties are located in areas that are known to be “disaster zones”, or areas prone to certain, often catastrophic, natural disasters. These zones are susceptible to earthquakes or flooding, which are events that could possibly decimate entire neighborhoods. For the homeowners and properties located in these hot zones, the standard homeowner’s insurance policy simply won't cut it.

Lenders will often require that home buyers purchasing properties in these designated disaster areas to purchase special insurance policies that deal directly with the type of disaster the area is prone to. These policies are separate and apart from the standard homeowner’s insurance policy, and are considered to be additional coverage. Flood insurance and Earthquake insurance are mandatory policies that are meant to provide the extra coverage needed in the wake of these catastrophic events.

What is Flood Insurance?

Some residential areas are located in flood zones, which are geographical locations that are prone to flooding. Homes in these areas are at risk of severe flood damage, and as a result, many lenders require that the home buyers looking to purchase a home in a zone that is deemed high risk for flooding also purchase flood insurance. Since the standard homeowner’s insurance policy doesn’t cover flood damage, additional coverage must be purchased.

It is important to note that flooding can occur in all 50 states, and well outside of these so-called special hazard flood areas. That said, it isn’t a bad idea for homeowners who aren’t explicitly required to purchase flood insurance to at least consider adding the coverage. Flood damage is no laughing matter for any structure and the assets in or around it.

A flood insurance policy is meant to provide coverage in the event of damage caused by a flood, which must meet specific criteria in order to be deemed as a flood. For example, in order to even make a claim, the flood water has to cover at least 2 acres of land that would normally be dry or has to have damaged at least two or more properties (including your home).

In addition to the above, the water must have come from one of these sources:

• Overflowing tidal or inland waters

• Runoff of surface waters from any source that accumulates in an unusual or rapid manner

• Mudflow (mud carried by a flow of water, causing a river of mud)

• Shorefront land collapse or sinking due to waters rising above “anticipated cyclical levels.”

Flood insurance is typically offered by most homeowner’s insurance providers and purchased from the National Flood Insurance Program (NFIP), which is operated by the Federal Emergency Management Agency (FEMA). Flood insurance focuses mainly on two areas of coverage, structural (dwelling) coverage and personal belonging coverage. The limit for structural coverage is $250,000 and the limit for personal belonging coverage is $100,000.

What is Earthquake Insurance?

For those who like to live on the edge (of a fault line, or in nearby areas) earthquakes are something to be extremely wary of. Anything that can literally shake the foundation of your home is cause for concern, and a disaster of this magnitude should be at the top of any homeowner’s watch-list. But enough with the earthquake puns.

Much like flooding, earthquakes can happen in a lot more places than you would think. Still, there are areas that are way more prone to earthquakes than others, and lenders are well aware of which homeowners must purchase this special coverage. Earthquake insurance policies are offered by most homeowners insurance providers, but the companies that the insurance is purchased from must be extremely cautious about how many homes they insure in one area.

A general rule with an earthquake is that if one home sustained damage, chances are many homes in the area sustained damage. Ultimately, it would bankrupt an insurer if an earthquake were to hit and decimate an area that was mostly under their coverage. That said, the calculation of earthquake insurance rates takes a ton of different factors into consideration.

For the most part, earthquake insurance policies are only truly beneficial for rebuilding purposes. The reason this is the case is due to the incredibly high deductibles found in the majority of the earthquake insurance policies on the market. Additionally, they don’t have the greatest coverage for personal belongings or even loss of use.

That said, a strong earthquake insurance policy should be formed around enough coverage to rebuild your home in the event of a total loss. This is particularly important for those homeowners who own property in high-risk areas.

How homeowner’s Insurance Works

So you have this coverage and a larger monthly mortgage payment from buying homeowners insurance. In an ideal lifetime, you may never have to use your homeowners insurance, even though it is mandatory and you are paying for it each month. But we can tell you, life tends to stray away from what is ideal, and into unknown territory, a lot more than most people tend to believe.

If that is the case, then there is no greater comfort (at least financially) than having a good homeowners insurance policy. Should your property sustain damages from an insured disaster such as a fire or hurricane, or even if it is burglarized and your personal belongings are taken, all you have to do after following the due processes required in either situation, is file a claim with your homeowners insurance provider. It is typically the same in terms of liability; should someone sustain an injury on your property, they can file a claim with your insurance provider for the damages.

Of course, that extends to liability coverage for when another individual’s property is damaged due to you or your family, as well as any legal costs that arise as a result of personal injury or similar claims. Remember, your insurance exists as protection for you. That is why it is so important to choose the right insurance plan that is not just affordable, but can provide a decent amount of coverage for these kinds of events.

Once claims are submitted to the homeowners insurance providers, then they must be processed. At that point, insurance companies typically send an insurance claims adjuster to evaluate the damage done, as well as the cost to repair, rebuild, or reimburse when necessary.

Once the cost is evaluated, they submit the claim amount to be approved. Independent insurance adjusters can be hired by the homeowner to dispute a claim or to ensure that they are getting enough money to repair or rebuild.

When a claim is finally approved, the homeowner must pay the deductible for the claim, which is an out of pocket expense that is made by the insured before the insurance company pays out the balance of the total claim amount.

For example, let’s say that an adjuster finds that your property has sustained damages that will require $10,000 in repairs and your insurance policy requires a deductible amount of $3,000. As the insured, you will be responsible for paying that $3,000 out of pocket, and the remaining $7,000 will come from your insurance coverage.

At the same time, the home is uninhabitable during the repairs, and you and your family must live elsewhere while the repairs are made. This too is claimable, and depending on your policy, will be paid upfront through your insurance provider or reimbursed after the fact. Regardless, a homeowner has significantly less to worry about with the right homeowners insurance policy.

Once the repairs have been completed, the company will often send the adjuster or a new adjuster back to inspect the repairs and make sure they have been done correctly, and up to specifications. Sometimes proof of payment is also required to make sure the money was used appropriately. After all, is said and done, and the home is cleared for habitation, you can move back in and resume your daily life.

Here’s the general rule for most homeowner’s insurance policies: the lower the deductible, the higher the premium, and the higher the deductible, the lower the premium. Finding a policy that works best within your budget is crucial, but never at the expense of reasonable coverage. Remember, it is still cheaper than having no way to pay for repairing or rebuilding your home out of pocket.

Why Lenders Require Homeowners Insurance

When entering a mortgage agreement, homeowners insurance is one of the major requirements from a lender. It is extremely common for the lender of your mortgage loan to specify the minimum required policy limits and to outline hazards that must be covered under the policy. Sometimes that means a homeowners insurance policy that at is at least equal in value to the remaining balance of your home loan.

On top of that, since earthquake or flood insurance isn’t typically a part of a standard homeowners insurance policy, lenders will make it a mandatory requirement for borrowers to purchase additional coverage for these disasters on top of the standard insurance policy. The additional coverage is required for any property purchase within a designated disaster zone. These zones are generally the riskiest of places to settle in, and mortgage lenders are aware of that risk, at least financially.

It may seem strange at first for your mortgage lender to actually require the purchase of insurance that seemingly only benefits the homeowner, but rest assured, it isn’t completely an act of goodwill. As a matter of fact, if you really look at from a lender’s perspective, it a protection of their investment. Mortgage loans use the property as a form of collateral until the loan balance is repaid in full.

Technically, until the loan is repaid, the house and its title belong to the lender or bank. Should a disaster occur, and the home is in need of repair or needs to be rebuilt, it is also in the best interest of the lender for there to be some form of insurance in place to cover the costs. For a homeowner it is protection against losing a home, but for the lender, it is protection against losing an investment.

See, unlike auto insurance, which is required by law for anyone who owns a car, homeowners insurance isn’t mandatory for a homeowner by law. Instead, it is a mandatory requirement by the lending institution servicing the loan, as a part of entering into a mortgage agreement. Technically, although it is highly discouraged, a homeowner can drop homeowner’s insurance if they have paid off their mortgage.

Regardless, it is actually of such great importance to a lender, that they usually have in-house or affiliated homeowners insurance policies that a homeowner can purchase during the mortgage transaction.

This is to ensure that even the most unprepared borrower has quick access to an insurance policy that at least covers the minimum requirements of the lender at closing. Still, it is more beneficial for home buyers to shop around for better homeowner’s insurance terms to get better coverage and possibly more affordability in terms of insurance premiums and deductibles.

Homeowners Insurance: In Review