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Homeowners Insurance Basics

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Homeowners Insurance BasicsYour home is likely the biggest purchase and investment of your life.  Losing your home or belongings in your home could be financially devastating.  Homeowners insurance allows people to insure their home and personal property and protect themselves from liability.

Homeowners insurance is generally purchased to replace or repair a home or personal property in the event of a covered loss, such as theft, vandalism, or fire.  Most homeowners insurance policies also cover temporary living expenses incurred as a result of a covered loss as well as a limited amount of personal liability coverage.

Additional Insurance Coverage

Unfortunately, your homeowners insurance policy may not provide all of the insurance you need for your home.

For example, the standard personal liability coverage that comes standard with most homeowners insurance policies is generally only $100,000 or so.  If someone were to slip on your porch and break their neck, you could potentially be sued for much more than that and lose much of what you own.

Make sure you purchase enough personal liability coverage.  Additionally, seriously consider obtaining an inexpensive umbrella liability policy to provide additional personal liability coverage on top of your auto and homeowners insurance policies.  Umbrella insurance is incredibly inexpensive for the coverage it provides, and is one of the best insurance values out there.

Certain losses are generally not covered by homeowners insurance, such as floods and earthquakes.  Flood insurance and earthquake insurance can generally be purchased separately to insure against those types of losses.

Additionally, you may need to obtain workers’ compensation insurance if you employ people in your home, such as a housekeeper or nanny.  Workers’ comp insurance will protect you if a domestic worker is injured in your home and suffers lost wages and medical bills.  If you don’t have insurance, you may have to pay for these costs out of pocket.

Saving Money on Homeowners Insurance

There are a number of ways to decrease your premiums or otherwise lower the cost of your homeowners insurance:

  • Get quotes from many different insurance companies to find the best rate.  This saves me hundreds of dollars a year.
  • Maintain a good credit score(FICO score)You can see your credit report for free but there is generally a small fee to see the score that your insurer sees.  If necessary, take steps to improve your credit.
  • Pay for insurance annually rather than monthly
  • Maintain appropriate safety measures in your home
  • Increase your deductible; however, you may want to build an emergency fund before considering this.  Also keep in mind that you will pay more out of pocket every time you suffer a loss and file a claim.
  • Maintain coverage equal to at least 80% of your home’s total replacement cost
  • Don’t file a claim every time you experience a small loss.  The cost of your deductible and the potential increase in premiums may make it more expensive to file a tiny claim than to not file a claim.  Additionally, file enough claims and some companies will refuse to insure you.

Replacement Cost vs Cash Value Coverage

Payments made by an insurance company in the event of a covered loss are generally computed in one of two ways:

1.  Replacement Cost Coverage

  • You are paid what it would cost to fix, replace, or rebuild your property (up to a maximum value specified in your policy), without adjusting for depreciation.
  • Replacement cost coverage tends to cost 10 – 20% more than comparable cash value coverage.

2.  Cash Value Coverage

  • The insurer only pays you for the market value of the loss after adjusting for depreciation, regardless of what it would cost to replace your property.  The older your property is, the more depreciation will lessen its market value and the more you could have to cover yourself out of pocket should something ever occur.
  • Insurance payouts are generally inadequate to fully replace, repair, or restore damaged or lost property.

In my experience, insurance agents tend to recommend replacement cost coverage in most cases.  However, that is not always the case.  For example, if your property is relatively new and very little depreciation has occurred, it may make sense to purchase cash value coverage.

It’s probably a good idea to beef up your emergency fund before choosing cash value coverage.

How Much Coverage

In general, insurance companies will not fully cover the cost of damage to a home unless the insurance coverage is equal to at least 80% of the home’s total replacement cost (not market value).  If the 80 percent rule is not met and your home is damaged by a covered event, you may have to pay for a portion of your loss out of pocket, even if your total coverage exceeds the cost of the loss.

Accordingly, most people should probably maintain homeowners insurance coverage equal to at least 80% of their home’s total replacement cost in order to be fully covered for any losses up to their coverage limits.  You should analyze your coverage at least annually to make sure that your coverage is still adequate.

One of the best ways for determining your home’s replacement cost is to have a home builder walk through your home with you and estimate what it would cost to rebuild it should something happen to your home.

Since it is fairly rare for a home to be completely destroyed, many people choose to insure their home only up to 80% of its total replacement cost, which is cheaper than fully insuring the home.  However, if your home is completely destroyed, you’ll be paying a lot out of pocket.

Additional Homeowners Insurance Tips

  • Use insurance companies that have been around for a while and that are financially sound.  You don’t want your homeowners insurance company going out of business right when you need it.
  • Make sure you understand any restrictions on your homeowners insurance policy.
  • Keep an accurate and updated inventory of your home and personal belongings using photos, video, appraisals, and a written inventory.  Store it away from your home in a safe place.  In the event of a loss you may need this to establish proof of ownership and value in order to be compensated by the insurance company.
  • Make sure you purchase enough homeowners insurance coverage so your home and personal possessions are protected.
  • Consider purchasing additional coverage for expensive items such as jewellery, silverware, and fur, since coverage with a standard policy may be capped between $1,000 and $2,000 for these items.

 Additional Information

For additional information on homeowners insurance (as well as other types of insurance) you might consider reading the below book:

What are your thoughts on homeowners insurance?  Leave a comment below!

Image: Yobro/Bigstock


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