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Homeowners insurance: What it covers and how much you'll pay

Yahoo Personal Finance· Getty Images
Michele Lerner
9 min read

When you buy a home and spend thousands of dollars on your down payment and monthly mortgage bills, it makes sense to want to protect that investment. Homeowners insurance, while not required by law, is typically a mandatory requirement by your mortgage lender and highly recommended by financial experts.

Homeowners insurance reimburses you for damage to your property caused by a covered peril. While there are variations in policies, most homeowners insurance covers the structure of your home and your possessions when damage occurs from something destructive such as a fire, a tornado, or theft.

Homeowners insurance protects both you and your lender. When your mortgage company provides the financing for your home purchase, the home and the land it’s on are the collateral for your loan. If your home is damaged or destroyed, the lender wouldn’t be able to sell it as-is to pay off the mortgage. Homeowners insurance, also called “hazard insurance,” pays to repair or rebuild your home.

Dig deeper: First-time home buyers — Everything you need to know

Most standard homeowners insurance policies cover the structure of your home and any structures on your property, such as a detached garage and your belongings. Homeowners insurance also provides liability protection and pays for extra living expenses while your home is being repaired or rebuilt.

Reimbursement for structural damage or your possessions depends on whether the damage is caused by a covered peril that is listed in your policy, such as a fire, a hurricane, lightning, hail, or theft. You typically can’t be reimbursed for damage caused by routine wear and tear, lack of maintenance, or an event that’s not listed in your standard policy, such as a flood or earthquake. Your possessions are covered even if they’re stored off-site or stolen when you’re away from home.

Liability protection covers you for court costs and damages up to the limits stated in your policy for an injury to someone else or damage to their property caused by you, your family members, or your pets. It also includes medical coverage for someone outside your family if they’re injured on your property.

The living expenses portion of your policy, which covers costs if you can’t live in your home while it’s being repaired, also has limits up to a certain amount of time or money.

Since homeowners insurance policies vary, it’s important to read your policy so you know what it covers and what it doesn’t. Generally, a standard homeowners insurance policy doesn’t cover damage due to a flood or an earthquake. There are separate insurance policies you can buy to cover those issues if you live in an area prone to them.

Damage to structural items such as a roof or a fence may not be covered under your homeowners insurance policy if the damage occurs because of a lack of maintenance or wear and tear.

Your homeowners insurance policy also has limits on your coverage, which means some expensive items in your home may not be covered. For example, if you have costly jewelry, art, or silver, you may need to purchase additional coverage, called a rider or an endorsement, for those items.

Your insurance agent can help you estimate how much homeowners insurance you should purchase. Generally, you want to buy enough homeowners insurance to rebuild your home if it's a total loss — but you don’t need to insure the land under your house. If you’re buying a home, you’ll know the home’s appraised value. Homeowners may want to evaluate their insurance coverage annually to make sure the insurance level is up to date with your home value, especially if you’ve made improvements.

To estimate how much coverage to buy for your personal possessions, you can do a home inventory. Typically, policies cover your personal belongings for approximately 50% to 70% of the amount of your structural coverage. In other words, if your home structure is insured for $400,000, your personal possessions coverage would be between $200,000 and $280,000. You may want to look at costly items such as jewelry and electronics to estimate their value and determine whether you need special coverage for them.

Liability coverage typically starts at $100,000, but if you have more assets, you may want to increase that coverage to a higher level with your regular policy or an additional umbrella insurance policy.

When estimating your homeowners insurance coverage, you should consider the difference between cash value and replacement cost coverage. Actual cash value coverage pays you the original value of your damaged items minus any lost value due to depreciation, while replacement cost coverage pays the cost to repair or replace items according to their current market value.

Most home structures have replacement cost coverage, while personal belongings may have cash value coverage. You can pay 5% to 25% more in premiums for extended replacement cost or guaranteed replacement cost coverage for your home structure.

According to the Insurance Information Institute, replacement cost coverage for your personal possessions costs about 10% more than cash value coverage.

Read more: How much house can I afford?

When you buy a home or want to change your homeowners insurance policy, you can take the following steps:

  • Get quotes. Contact several insurance companies or an insurance agent who works with multiple providers to get a quote. Be sure to request a quote for the same amount of insurance coverage and the same deductible and to compare the terms of each policy.

  • Read reviews. Companies such as J.D. Power and AM Best survey consumers about their experience with various insurance companies. You can also check online for customer complaints and compliments.

  • Discounts. Ask each homeowners insurance provider about available discounts, such as for an alarm system or bundling your home policy with another insurance policy.

  • How to pay. Insurance companies typically bill quarterly, semi-annually, or annually. Many mortgage lenders require homeowners insurance to be paid through an escrow account, which means you’ll pay part of your premium with each mortgage payment, and the lender will pay the bills from your escrow account.

Dig deeper: What does PITI mean, and how does it affect your mortgage?

Homeowners insurance costs vary widely, but the average cost in the United States is $2,601 annually for $300,000 in dwelling coverage and liability with a $1,000 deductible, according to a recent study by Insurance.com. This would come to $217 per month, along with your mortgage principal, interest, property taxes, and any mortgage insurance you might have.

Multiple factors influence what your homeowners insurance will cost, including the location, size, and condition of your home. It can also depend on whether you have a mortgage, the level of coverage you purchase, the size of your deductible, the construction materials in your home, your credit score, and whether you have previous insurance claims, according to Experian, a credit rating bureau. Insurance companies evaluate risk, so if your home is in a location prone to storms or if you have certain features that could add risk to your property, such as a swimming pool or a hot tub, your rates may be higher.

You can lower your premiums if you raise your deductible, improve your credit score, or add a feature such as a security system. You also might be eligible for a discount offered to veterans, students, or another group.

Learn more: How much money do I need to buy a house?

Another way to keep your premiums lower is to avoid making too many homeowners insurance claims. However, homeowners insurance is in place to protect you financially from costly damage or even the destruction of your home due to an unforeseen event.

If you need to make an insurance claim, call your insurance company right away. If the claim is due to theft, file a police report. Keep all of your notes and documents throughout the claim process, including photos of the damage. Make a list of what needs to be done to return your house to its previous condition or to replace damaged, destroyed, or stolen items.

Your insurance company will have forms for you to complete and will send an insurance adjuster to estimate the damage. Follow the insurance company’s instructions about making initial repairs or cleaning up the damage, document your work, and keep all receipts.

Your lender will likely give you an estimate based on the amount of your mortgage and the cost to replace your home, but you may want to estimate your own coverage preference. Evaluate the current cost to replace your home (minus the land), how much it would cost to replace all your possessions, and your liability coverage based on your assets.

Many lenders require homeowners insurance premiums to be paid into an escrow account with your monthly mortgage payment to ensure the homeowners insurance is up to date. If you stop making your homeowners insurance payments, your lender could charge you for a “force-placed” insurance policy, which is typically much more costly than a standard policy and only protects the lender’s financial interest in the property, not your possessions or liability.

While homeowners insurance isn’t required by law, it’s recommended to have this insurance to protect your financial interests in your home, even if you don’t have a mortgage. Severe damage to a home from a fire or storm, loss of property due to theft and vandalism, or total loss of a home to a hurricane would mean a financially devastating loss without insurance to cover the expense of rebuilding.

Homeowners insurance protects your home and possessions against specific risks such as fire, hurricanes, and theft, along with providing liability protection in case someone is injured in your home. Mortgage insurance provides protection for your lender in case you default on your loan. It’s typically required on government loans such as FHA (Federal Housing Administration) loans, and on conventional loans when you make a down payment of less than 20%.