How Does Homeowners Insurance Work?

Homeowners insurance provides coverage to repair or rebuild your home after events like fire, smoke, theft, vandalism, a falling tree, or damage caused by weather such as lightning, wind, or hail. Most standard homeowners insurance policies also cover furniture, clothing, and other possessions. In addition, they cover medical expenses and legal fees if people other than you, your family, or anyone else not living in your home is injured on your property. The same guidelines generally apply to renters insurance, as well as policies for condo and mobile home owners. 

Most standard policies will also provide coverage for outbuildings on your property, such as a garage, barn, or shed, along with outdoor grills or firepla

If your homeowners insurance company doesn't offer flood insurance, you may be eligible for coverage through the National Flood Insurance Program, administered by the Federal Emergency Management Agency. NFIP policies are offered through independent agents nationwide. Costs and requirements can vary widely depending on the risk factors where you live. FEMA‘s website includes an interactive flood map that can help determine the risk in your area

Depending on your occupation, interests, and circumstances, you may want to consider optional coverage for home office, specialized equipment or musical instruments, or high-end audio, video, or computer systems. Identity theft or data loss coverage is also an option. 

To determine whether you need additional coverage beyond what's included in a standard homeowners insurance policy, start with the most obvious factors. If you live in or are thinking about buying a home in an area prone to earthquakes, wildfires, or extreme weather, look for a policy that covers those events.

Next, think about what it would cost to replace major items such as a furnace, a water heater, a roof, or even your entire home. Talk to an independent insurance agent, call insurance companies directly, and check company websites for guidelines. Take an inventory of your possessions, including your vehicles, artwork, and other valuables. Consider what it might cost to live with relatives, in a hotel, or in a rental unit while your home is being repaired or rebuilt.

A basic rule of thumb is to make sure you buy enough coverage to replace your home and its contents, as well as to cover additional living expenses if you have to move out. Be honest in your assessments and make sure that any policy you consider is sufficient.

What Are the Types of Homeowners Insurance?

There are two basic types of homeowners insurance: actual cash value policies and replacement cost policies. An actual cash value policy factors in depreciation and inflation, meaning that reimbursement for appliances and upgrades made to a kitchen 10 years ago, for example, would be paid at some percentage of their original cost. A replacement cost policy ensures that items are replaced with comparable new ones without accounting for depreciation or inflation.

An actual cash value policy could leave you short of funds to rebuild your home in the event of a total loss. “The cost to rebuild your home may change over time, due to rising construction costs and other inflationary pressures,” says Iowa Insurance Commissioner Doug Ommen. Many factors are at play here, from how long you've owned your home, to fluctuations in property values, to changes in building codes and material and labor costs. 

For example, rising property values could make your home worth several times more than when you bought your policy, with corresponding increases in material and labor costs. Stricter building codes may require additional and more costly materials than those used when your home was originally constructed. In addition, some older homes may have been built using materials and methods that are no longer widely used and are consequently expensive to replicate. Walls of plaster and lath, for instance, require more labor and materials than modern drywall. If you want to recreate your home as it was, you'll have to account for these additional expenses.

For these reasons, every insurance industry expert we spoke with recommended purchasing a replacement cost policy if you can afford one. 

How Do I Get Homeowners Insurance?

Home insurance is available through a variety of sources, including company websites, toll-free telephone numbers, and independent or dedicated local insurance agents. Major home insurance company websites are a great place to begin your search and generally have a wealth of information about standard and optional coverages. Many also have estimating tools that can give you an idea of what your premiums will be once you enter some basic information about yourself and your home.

While it's a good idea to compare coverage and rates from different companies using these tools, the insurance industry experts we spoke with recommended doing additional research online. For example, most state insurance departments offer websites with useful information, including state requirements, licensing regulations, buying advice, and consumer complaints. The National Association of Insurance Commissioners is another excellent resource. Its website provides consumer advice and features an interactive map with state-specific regulations and other information, along with contacts for local insurance agents. 

Even with all the resources available online, it's a good idea to work with a local agent or insurance professional. Policy details can be hard to decipher, and getting the right coverage is critical to avoid a costly mistake. “We always advise consumers to get professional assistance to guide their coverage choices,” Ommen says. He also said it's important to check your agent's credentials through your state's insurance department. Most state insurance departments are easily found online and have tools to help you find a licensed agent in your area. Listings include license numbers and expiration dates, so you know the agent is in good standing. Another helpful tool is on the NAIC site, which lets you select an insurance company and then click on your state to see complaints and actions against agents in your area.

Robert Hunter of the Consumer Federation of America says that while using an agent is a good idea, it's important not to rely blindly on their advice. “95% of agents are good,” he says, but not all of them have your best interest at heart. While an agent can help you navigate policy coverages and exceptions, it's important to do your homework and ask the right questions to make sure your coverage is sufficient. “Things that can bite you include hidden coverage limits,” says Amy Bach, executive director of the consumer group United Policyholders. The more knowledgeable you are the better, which may mean imagining scenarios where things go wrong and asking yourself, “Would that be covered?” One example is sump pumps. While you might have coverage for water damage caused by a burst pipe, most insurance policies don't cover a sump pump failure. 

Is Homeowners Insurance Required?

Homeowners insurance isn't required by law, but that doesn't mean you won't be required to get it. If you plan on financing your home, your lender is most likely going to require homeowners insurance to protect their investment. In addition, condominium associations or private communities typically require home insurance. 

That said, even if your home is paid off or you paid cash for it, home insurance coverage is a good idea. Most homeowners can't afford to rebuild or make substantial repairs if their home is heavily damaged or destroyed. Even if you have the funds, a homeowners insurance policy costs a lot less than rebuilding out of pocket.

ces, swing sets, walls, and fences. A swimming pool or other recreational equipment may also be included, but higher-risk items such as these may require additional coverage.

Additional items that may not be included in a standard policy are artwork, jewelry, or other collectibles that are worth more than standard coverage allowances. This is one reason it's important to read and understand the limits of any policy you're considering and purchase additional coverage when necessary.

Most standard home insurance policies don't include earthquake and flood coverage. These types of coverage are generally available at extra cost, but all insurers may not offer them in all areas.

How Much Does Homeowners Insurance Cost?

The cost of homeowners insurance varies widely, based on the amount of risk an insurer is taking on, along with local building costs and other factors. Insurance companies use complicated algorithms to determine rates, taking into account a wide range of criteria, including the size, age, location, and condition of your home, along with the materials used in its construction. A larger home will generally cost more to insure than a smaller one because it requires more labor and materials to rebuild it. A newer home is usually cheaper to insure than an older one because generally you can expect fewer problems to arise. 

Historical claims data and local weather conditions also play a part. If homeowners in your area have filed a lot of claims over the years, your rates will probably be higher. A home in an area prone to flooding will cost more to insure, as will an oceanfront home with greater exposure to wind, waves, and erosion. The same applies to homes in areas at higher risk of an earthquake, tornado, or other weather events. The local crime rate, and thus the risk of burglary, is another factor.

Deadbolt locks, burglar and fire alarms, and security systems all can reduce homeowners insurance rates, while higher-risk items like swimming pools, ponds, or trampolines can do the opposite. Maintaining a good credit rating can significantly reduce your rates, while a prior history of homeowners insurance claims and even aggressive pets can raise your premiums. 

Even with all of these variables, some homeowners insurance companies are more affordable for the sample property we used in our ratings. To compare homeowners insurance rates, we used a prototypical 2,400-square-foot, three-bedroom, two-bath townhome in Naperville, Illinois, valued at about $450,000. We found monthly premiums for our sample home varied from a low of about $98 per month with Erie, to $169 per month with Allstate. That works out to an annual savings of more than $850 with Erie, at $1,176 per year. The annual cost for the same home with Allstate would be $2,028.

What Does Homeowners Insurance Cover?

A typical homeowners insurance policy provides coverage to repair or rebuild your home if it's damaged by fire, smoke, theft, vandalism, or bad weather such as lightning, wind, or hail. A standard homeowners policy also generally covers heating and cooling systems and their components, such as a furnace, a water heater, or an air conditioner, along with ductwork as long as the reason for the claim is an event covered by the policy. It doesn't cover wear and tear, component failure, or anything else normally covered by a manufacturer's or home warranty. 

In addition, a standard homeowners insurance policy typically covers personal property. This includes bedding, clothing, electronics, furniture, and anything else you own that's inside your home. 

All home insurance policies have coverage limits that may or may not be sufficient to repair or replace your home and its contents, and are customizable with additional coverage for some or all categories as needed. The key is to determine how much coverage you need and to shop around for the best price for that coverage.

Most standard homeowners policies limit reimbursement for more expensive items such as jewelry, artwork, or other collectibles, so these might require additional coverage. Other options include services like identity theft protection and additional coverage for home office equipment. 

Depending on where you live, flood or earthquake insurance may be important or required. Neither is included in most standard homeowners insurance policies. In some locations, flood insurance may not be available through your insurer of choice. If so, you may be eligible for coverage through the National Flood Insurance Program, administered by the Federal Emergency Management Agency. NFIP policies are offered through independent agents nationwide. Costs and requirements can vary widely depending on the risk factors where you live. FEMA‘s website includes an interactive flood map that can help determine the risk in your area.

Also, homeowners insurance policies cover your additional living expenses while your home is rebuilt after a fire or some other event renders it uninhabitable, forcing you to move out. You would only be reimbursed for living expenses above and beyond your normal expenses, such as for a hotel room and restaurant meals. Additional living expense coverage can also compensate you for lost rent from a tenant renting a room who is also forced to move out. 

Finally, homeowners insurance policies provide personal liability coverage if someone is injured in your home. For example, if a guest slips and falls in your home, this liability coverage would help pay for medical and legal bills. 

For more information, see What Does Homeowners Insurance Cover?

How Much Homeowners Insurance Do I Need?

The basic rule of thumb is that you should have sufficient homeowners insurance coverage to repair or replace your home and everything in it after a total loss. Potential repairs include the main structure, any outbuildings or structures such as a garage, pool, or fence, and your furniture, clothing, and other possessions. Determining the cost of replacing your home and its contents is a more manageable task than it may appear. The Insurance Information Institute can help walk you through the process, as can a licensed insurance agent or realtor. 

To get a rough idea of the replacement cost for your home, multiply the square footage by the local building cost per square foot. For example, if your home is 2,200 square feet and building costs average $80 per square foot, the cost to rebuild your home would be about $176,000. Ask an insurance agent, real estate agent, or appraiser about building costs in your area. 

The next step of determining how much home insurance you need is to inventory all of your personal property. Note when and where you purchased items, particularly expensive ones. Take photos and videos and save receipts if you have them. The better your documentation, the easier it will be to file a claim should you need to. Don't forget outdoor furniture and equipment such as a barbecue grill, along with collectibles, musical instruments, hobby and sporting equipment, items tucked out of sight such as linens and silverware, and items stored in the attic or garage. Consider what it would cost to replace each item with an equivalent new item, not what you paid for it initially. Replacement costs can change quickly, and even a 2-year-old appliance might be considerably more expensive today than when you bought it. 

Once you've calculated rebuilding costs and taken a thorough inventory of your belongings, you'll have a good idea of how much homeowners insurance you need.

Who Shouldn't Get Homeowners Insurance?

If you finance your home, your mortgage lender will probably require you to buy a homeowners insurance policy. That's because lenders want to be able to recoup their investment in the event of a loss. If you pay cash for your home or pay off your mortgage, you may not technically need homeowners insurance. However, experts say that skipping homeowners insurance to save a bit of money is a bad idea, even if you have the option to do so. “Obviously, there are some people who could afford – even easily afford – to lose a home,” Hunter says. “But for most people, a home is their largest asset, and losing it would be a financial disaster.”

When shopping for a homeowners insurance policy, look for one that provides the coverage you need at a price you can afford. In addition, choose one from a reputable company that scores well in our ratings and provides insurance in your area. It's also a good idea to interview a few insurance agents to find the one you want to work with.

“Do your homework about insurance companies online,” says Iowa State Insurance Commissioner Doug Ommen. “We always advise consumers to go to their state insurance website. Some states provide information about complaint activity.” Also, choose a company with a good financial strength rating from AM Best or another rating agency.

Work with your agent to make sure you have sufficient coverage for anything beyond what's typically covered in a standard homeowners insurance policy. While most policies cover your home, outbuildings, furniture, appliances, and other possessions, standard policies have limits for various categories and items. Jewelry, artwork, and collectibles may require additional coverage if their value exceeds these limits. “Talk with your insurance agent and consider your belongings,” says Janet Ruiz, director of strategic communications with the Insurance Information Institute. “If you have expensive art collections, a very large home, intricate woodwork, etc., you may need extra coverage options.”

Once you've taken an inventory, it's important to keep it current. Review your insurance needs every year and include new items. “Anything new you brought into the house may not be covered,” Ommen says. “Jewelry or a gift could exceed your limits. We tend to lock ourselves in and lose track.”