What Is Homeowners Insurance and How Does It Work?
Homeowners insurance is a type of coverage that pays out if your home or personal property suffers damage due to an accident such as a fire or certain natural disasters. It also includes personal liability coverage, which protects you against lawsuits if someone has an accident or injury on your property.
Homeowners insurance isn't required by law, but if you take out a mortgage, your mortgage lender will require you to have a homeowners insurance policy to protect their investment.
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.
Read on to learn more about what home insurance covers and how it works.
What does home insurance cover?
Homeowners insurance has four different types of coverage:
- 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 insurance includes the structure of your home and additional structures on your premises (such as detached garages and sheds).
As for your personal property, a home insurance policy helps cover 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.
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 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.
|Fire or lightning||✓||✓||✓||✓|
|Windstorm or hail||✓||✓||✓||✓|
|Riot or civil commotion||✓||✓||✓||✓|
|Vandalism or malicious mischief||✓||✓||✓||✓|
|Volcanic eruption (but not earthquakes or tremors)||✓||✓||✓||✓|
|Weight of ice, snow or sleet||✓||✓||✓|
|Accidental discharge or overflow of water or steam||✓||✓||✓|
|Sudden and accidental tearing apart, cracking, burning or bulging of a steam or hot water heating system, air conditioning or sprinkler system or water-heating appliance||✓||✓||✓|
|Freezing of plumbing, heating, air conditioning or sprinkler system or a household appliance||✓||✓||✓|
|Sudden and accidental damage from an artificially-generated electrical current||✓||✓||✓|
*HO-5 policies are "open-peril," meaning they'll cover any damage unless the peril is specifically named and excluded.
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 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.
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.”
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.
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.
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.
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 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.
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
- Nuclear hazard
- Intentional loss caused by you
- Government action
However, damage related to these perils may be covered in some situations.
For example, while damages from the direct effects of an earthquake aren’t included in homeowners insurance, fire damage caused by an earthquake is.
Your policy may also reimburse you for expenses such as living costs while earthquake damage to your home is repaired.
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?
In 2017, the average annual homeowners insurance premium was $1,211. Your insurance rates will depend on where you live and the coverage limits you choose.
Location and coverage options
For example, if you’re in an area with a high crime rate, your insurance premium may be higher because you’re more likely to file a claim for theft.
If your house includes a premium home theater room, and you adjusted your personal property limits upward to cover its cost, you’ll probably pay more in premiums due to the potential cost to replace the theater should it be destroyed by fire, for example.
The deductible you select also affects your cost. The deductible is the amount you must pay out of your own pocket before the home insurance coverage kicks in. A high deductible will result in a lower premium and vice versa.
Actual cash value vs. replacement cost
Another factor that helps determine your premium is the type of reimbursement you select.
You can choose either actual cash value, which means the coverage is subject to depreciation, or 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.
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.
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.
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.
To learn more, check out our guide on the best home warranties.
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.