What Is Homeowners Insurance and How Does It Work?

Many people let their homeowners insurance policy lapse once the mortgage is paid off, but the financial protection homeowners insurance offers can be a life-saver for many homeowners.

But what is home insurance and what does it cover? Read on to learn more about what home insurance covers and how it works.

Table of Contents

• What does home insurance cover?
• Types of homeowners insurance
• Home insurance vs. home warranties
• What is excluded from homeowners insurance?
• How does homeowners insurance work in disaster-prone areas?
• How much does homeowners insurance cost?
• Requirements to buy homeowners insurance
• How to buy homeowners insurance
• Homeowners insurance FAQ
• Summary of Money’s guide to homeowners insurance

What does home insurance cover?

Homeowners insurance has four different types of coverage, so let’s take a look at each:

• Property coverage for the actual house and other structures you may have on the grounds

• Personal belongings or personal property coverage in case they are damaged or stolen

• Loss-of-use coverage pays out if you need to leave your house during repairs

• Personal liability coverage to pay medical bills if you’re found legally responsible for someone’s bodily injury or property damage

Property Coverage

Property insurance includes the structure of your home and additional structures on your premises (such as detached garages and sheds).

Personal Belongings

As for your personal property, a home insurance policy covers damage to your personal (not business-related) belongings, wherever they may be lost or damaged, or items that belong to other people if those are in your dwelling.

Your insurance company may place policy limits on the belongings that are covered, at least without special riders, or may only cover them up to a certain amount. You may need additional coverage for high-value items like jewelry and artwork.

To determine your personal property coverage, you should create a detailed home inventory, with cost and receipts included if possible, which can also help a claims adjuster determine the value of the damage later.

Loss of Use

Loss-of-use coverage pays for your additional living expenses if your home is damaged and you need to stay elsewhere while the damage is repaired. This coverage could even pay for meals and transportation if necessary.

Personal Liability

Additionally, homeowners insurance covers your personal liability when you’re sued for causing bodily injury or property damage, or for medical payments to others when their injury is caused by you or due to a condition in your dwelling (e.g., if an uneven front step causes someone to fall and break a bone).

Keep in mind that some companies exclude you from liability coverage if you have a “high-risk” dog breed.

If you need more liability coverage than your insurance company is willing or able to sell to you, you might consider an umbrella liability policy, which can cover a wide range of covered perils (such as additional liability under your auto insurance policy) with higher coverage limits.

Types of homeowners insurance

There are eight types of homeowners insurance policies. Some of them have become obsolete as policyholders have demanded more coverage; others are designed for specific types of properties.

The HO-1 “basic form" is the simplest type of homeowners insurance policy. It works on a “named perils” basis, meaning the policy lists which perils the policy will cover. If it’s not explicitly listed, it’s not covered.

Because of their limited coverage, HO-1 policies are rarely sold nowadays.

HO-2

HO-2 policies, known as “broad form” policies, work just like HO-1 policies but they expand the list of perils to 16. Like HO-1 policies, HO-2 policies are practically obsolete these days.

HO-3

An HO-3 policy, also known as “special form,” is the standard homeowners insurance policy and the most common. It offers a good balance between the amount of coverage and cost.

With this policy, the structures on your property are covered on an “open perils” basis. This means the insurance will cover any claims that may arise except for those explicitly excluded in the policy. Compare that to an HO-2 policy which will only cover damage caused by the listed events.

When it comes to your personal belongings, however, an HO-3 policy will only cover them if they are lost or damaged because of one of 16 “named perils.”

HO-4

An HO-4 policy isn't exactly a homeowners insurance policy. This is what is commonly called renters insurance, and it is very similar to the HO-3 homeowners coverage, except it excludes dwelling coverage. When you rent a property, the homeowner is responsible for the insurance and upkeep of the structure. As a tenant, renters insurance can help you cover your personal belongings and personal liability.

HO-5

An HO-5 policy, also known as a “comprehensive” policy, is very similar to an HO-3 policy but has broader coverage. However, it’s not as common as HO-3, possibly because it’s more expensive.

With this policy, all your property, including your dwelling, structures, and personal belongings, are covered on an “open perils” basis.

This means the policy will cover everything except what’s explicitly excluded in the coverage.

Compare this to an HO-3 policy, under which only the dwelling is covered on an open perils basis, while personal belongings coverage is limited to 16 perils.

HO-6

Another common type of homeowners insurance policy is HO-6 or condo insurance. This type of policy is only for people who live in condominiums. It’s a “named perils” policy, so it will only cover damage caused by the events listed on the policy.

Since condo associations have insurance that covers the building structure and common areas, an HO-6 policy will cover what is inside your unit, like wiring and plumbing, while some policies also cover fixtures and appliances.

HO-7

This is known as “mobile home insurance” and covers the structure of your trailer, RV, or modular home in the same way HO-3 policies do, on an “open perils” basis.

HO-8

HO-8 policies are also called “modified coverage” policies because they’re intended for houses that don’t meet the guidelines to be covered under the other policies. For example, some insurers limit their HO-3 policies to newer homes or those that pass a thorough inspection.

If you own an older home or a historical landmark that can’t be upgraded for conservation reasons, you’ll need to purchase an HO-8 policy.

Home insurance vs. home warranties

Homeowners insurance shouldn’t be confused with home warranties.

A home warranty isn’t a type of insurance at all. Instead, it’s a service contract offered by a home warranty company that will repair or replace major systems — such as HVAC, plumbing and wiring — and appliances like refrigerators, washers and dryers.

The way a home warranty works is that you pay a premium — which can range from $300 to $600 annually, depending on your home’s amenities— and whenever something needs to be repaired, you pay a service fee between $50 and $200 to have a repair person evaluate and fix the system or appliance.

One thing to keep in mind when it comes to home warranties is that the service contract does not cover appliances covered by the manufacturer’s warranty.

Homeowners insurance, on the other hand, does not cover freestanding appliances like fridges and washers. You would have to pay out of pocket to repair them if something were to happen to them.

Take a look at the differences between the two below:

To learn more, check out our guide on the best home warranties.

What is excluded from homeowners insurance?

As we mentioned earlier, the most common homeowners insurance policy called HO-3 covers the structure of the home on an "open perils" basis.

All causes are covered except for those explicitly excluded in the policy.

HO-3 policies exclude the following perils from coverage:

• Ordinance or law
• Earth movements, including earthquakes, landslides and sinkholes
• Water damage, including flood, sewer backup or sump pump overflow
• Power failure
• Neglect
• War
• Nuclear hazard
• Intentional loss caused by you
• Government action

Damage related to the perils mentioned above may be covered in some situations. For example, insurance providers may cover damages in a power outage.

In addition, most policies exclude damages from the direct effects of an earthquake but will cover fire damage caused by an earthquake. Your policy may also reimburse you for expenses such as living costs while your home is repaired after earthquake damage.

How does homeowners insurance in disaster-prone areas work?

In many cases, the basic homeowners insurance policy isn’t enough to protect your home. For example, floods and earthquakes aren’t covered by homeowners insurance, regardless of where you live.

Homeowners in earthquake and flood-prone areas should look into separate earthquake and flood insurance in addition to homeowners insurance to better protect their homes and families. In addition, you may need yet another policy to cover your personal belongings for flood and earthquake damage.

The National Flood Insurance Program is a federal program that backs flood insurance in flood-prone areas to make it economically accessible to even more people.

Similar programs have been formed to lower earthquake and wildfire insurance costs.

Damage from wildfires is generally covered under regular homeowners policies. However, policies may be difficult or very expensive to purchase, at least from regular insurers, in areas of states that are particularly prone to wildfires.

Some states —such as California, Florida, and Texas— have state-backed insurance companies that sell policies to cover wildfire risk.

How much does home insurance cost?

According to the National Association of Insurance Commissioners, the average annual homeowners insurance cost was $1,319 in 2020. Keep reading to learn more about homeowners insurance rates.

Variables that affect the cost of home insurance

The cost of homeowners insurance depends on many different factors. Take a look at some of them below.

State and ZIP code

Your location is one of the biggest variables affecting your homeowners insurance premiums. Homeowners insurance may cost more if your home is in an area known for extreme weather events or natural disasters. However, your rates may be lower if you are close to a fire department or fire hydrant (usually within 100 feet).

Property in rural or suburban areas typically have lower home values than those in urban areas, so homeowners insurance tends to be more affordable.

Structure of home

The more expensive it is to rebuild your home, the higher your rates will be. The square footage, materials and local construction costs can all factor into the cost of your homeowners insurance. You’ll likely pay more in premiums if the house was custom built or has special features like a home theater you’d like to insure.

Age of home

Older homes cost more to insure. They may have building materials that cost more to repair and older appliances and electrical systems that increase the risk of a fire. During a rebuild, some parts of the home may need to be updated to get up to code, which also costs the insurance company more.

Credit score

People with lower credit scores may pay more for homeowners insurance if they live in a state where carriers determine rates based on credit history. Insurance companies may view someone with a low credit score as riskier and less likely to pay their premiums on time.

Claim record

Having a frequent claims history is a bad sign for insurance companies. Insurance carriers might also increase your rate after making a claim that is likely to happen again, such as theft and dog bites. Sometimes, covering expenses on your own might be cheaper than filing a claim and thus increasing your premiums.

Deductibles

The deductible is the amount you must pay out of your own pocket before the home insurance coverage kicks in. For example, if your deductible is $1,000, and you have damage that costs $5,000, you would pay $1,000, and your policy would cover $4,000. A high deductible will result in a lower premium and vice versa.

Type of reimbursement

Another factor that helps determine your premium is the type of reimbursement you select.

The first option is actual cash value, which means the coverage is subject to depreciation. The second option is to request replacement cost, which reimburses the full cost to replace the covered loss with an equal or similar item.

This last option results in higher premiums because it’s typically more expensive for the insurance company to cover.

Discounts

You can usually get a discount on your premiums if you pay them annually in advance or via automatic electronic payments or renew your policy more than 30 days before it expires.

Other common discounts include those for owning protective equipment such as smoke detectors, burglar alarms, sprinklers, extinguishers, or security cameras.

If you bundle your home insurance coverage with car insurance, you may receive an additional discount.

Requirements to buy homeowners insurance

You must live inside the home to buy homeowners insurance since insurance companies find unattended homes riskier than those with occupants keeping an eye on them.

Insurance carriers may also require certain safety features in your home, especially if you’re looking to get discounts. You might lower your premium by installing smoke detectors or a security system.

Lastly, it’s important to evaluate the value of your property and possessions in order to obtain an accurate insurance quote. Consider working with professionals, such as appraisers, to assess the worth of your home and determine the cost of rebuilding it in the event of a disaster.

Make a full inventory that includes all your valuable possessions, such as furniture, jewelry, hobby equipment, collectibles, electronics, appliances and other items you would need to replace if they were damaged or destroyed. Include as many details as possible, including photos or videos.

How to buy homeowners insurance

You can purchase homeowners insurance coverage yourself through your favorite home insurance company. Requesting a home insurance quote online or over the phone can take as little as fifteen minutes. Most companies let you file insurance claims online as well.

Alternatively, an insurance agent can help you compare coverages and build the policy that's right for you.

Shop around early if you’re selling your home and getting insurance on your new property. You need an entirely new policy and, if you’re financing your new home, you’ll need it in order to close the loan and access the funds.

Summary of Money's guide to homeowners insurance

• Homeowners insurance protects your home and personal belongings from vandalism, theft, fire and other perils.

• Homeowners insurance also includes personal liability protection, which covers legal costs if someone were to suffer bodily injury in your home and you’re found responsible in a court of law.

• An HO-3 policy, the most common kind of homeowners policy, covers all perils that damage the structure except those explicitly excluded from the policy.

• Some of the exclusions include earthquakes and flooding; you’ll need separate policies for that.

To learn more about homeowners insurance and how to find the policy that’s right for you, check out our page on the best homeowners insurance companies.