How To Understand Your Homeowners Insurance

Updated September 22, 2016
tornado damaged home
A tornado or high winds can damage your home's roof and destroy windows. Make sure your insurance policy covers a variety of damage. (Photo by Nick Oxford)

Policies are tricky to decipher; welcome to homeowners insurance 101.

If a catastrophe hits your home, and you’re left with nothing but the shirt on your back, you want to make certain your insurance coverage will allow you to rebuild and replace what you’ve lost.

It’s important to know what your homeowners insurance covers, especially because policies are long, complicated and typically written in legalese, which can make it difficult to understand how it works.

“Generally speaking, clients have very little knowledge of what their homeowners policy covers or includes,” says Winfred Seymour, account executive at Humble & Davenport Insurance in Renton, Washington. “Even when directly reading the policy declaration, let alone the policy contract, most folks don’t understand what it all means.”

It might not be the most exciting thing on your to-do list, but evaluating your insurance coverage could end up being a lifesaver should disaster strike.

A standard homeowners insurance policy

Homeowners insurance covers both damage to property and liability for any injuries that occur in your home or on your property. For example, if you slip and fall on your neighbor’s porch, your neighbor’s insurance should cover any expenses related to your injuries.

A standard homeowners insurance policy should include the following four components. If yours doesn’t, ask your insurance agent why not.

1. Coverage for the structure of the home: This part of a policy pays to repair or rebuild a home if it gets damaged or destroyed by fire, hail, lightning or other disaster listed in the policy. It will not pay for damage caused by a flood, earthquake or routine wear and tear. Most standard policies also cover structures that are not attached to a house, such as a garage, tool shed or gazebo.

2. Coverage for personal belongings: Furniture, clothes and the contents of your home. Trees, plants and shrubs are also covered under standard homeowners insurance, generally up to $500 per item.

3. Liability protection: Covers against lawsuits for injury or property damage that policyholders cause to other people. It also pays for damage or injury caused by pets. A standard policy typically will cover the first $100,000. If you think you need additional protection, consider umbrella coverage, which increases the monetary limits beyond a traditional homeowners insurance policy.

4. Additional living expenses: Pays for the costs of living away from home if your house becomes inhabitable due to the damage. It should cover hotel bills, restaurant bills, and other living expenses. It varies from company to company, so it’s important to see how much coverage you actually have.

If you aren’t sure what your policy includes, ask your agent. He or she is there to make certain you understand what’s covered and what’s not should you need to file a claim.

Homeowner Katie Smith of Blaine, Minnesota, says she recently switched insurance companies, and despite paying a few hundred dollars more a year, is much happier with the extend of the new coverage it provides.

“My new policy does cover more, mostly it covers the loopholes that my old policy didn’t, she says. “For example, if a tree fell on someone in my yard, the medical bills would be covered now by my insurance, but they weren’t in my previous policy. Always read the fine print and ask questions if you don’t understand. If someone won’t explain the fine print, don’t just shrug it off, it probably means they’re hiding something.”

Also keep in mind that some damages might be best left unclaimed. Homeowners who file multiple claims within a short period of time risk losing their insurance altogether.

“It’s a misconception that whenever there is a loss they should call in a claim,” says Troy Thompson, owner of Pinnacle Insurance Agency of Minnesota in Coon Rapids, Minnesota. “Small home losses should be handled by the homeowner, not the insurance company.”

Replacement value vs. actual cash value

It’s important to know whether your coverage includes the “actual cash value” or “replacement value.” Of the two, actual cash value is less desirable.

Otherwise known as market value, actual cash value is the amount it would take to repair the damage or to replace contents after allowing for depreciation. In other words, if you paid $2,000 for a sofa 10 years ago, you’ll only receive an amount correlating to its value today (probably not $2,000 anymore).

Replacement cost is the amount it would take to rebuild or replace a home and its contents with similar quality materials or goods, without deducting for depreciation. So, regardless of what your sofa is currently worth, the insurance company will give you enough money to purchase a similar one today. This type of policy is more expensive, but oftentimes the preferred choice for homeowners.

Understand what’s not covered

Standard homeowners policies don’t cover flooding, earthquakes or “disaster” due to poor upkeep and maintenance of a household system. If you live in a designated flood plain, your mortgage company is more than likely going to require you to buy flood insurance. If you own your house outright, buying flood insurance (or any homeowners insurance for that matter) is optional.

The National Flood Insurance Program is a government-operated insurance program and provides the only option to buy flood insurance. However, it’s facilitated through your local insurance companies. The average flood insurance policy costs around $700 a year, but of course prices will vary depending on the size of your home and where exactly you’re located in a flood plain.

For earthquake coverage, the cost depends on where you live. Other factors include the age of your home, materials used (wood withstands quake stress better), soil consistency (land that’s loose or contains excess moisture is more vulnerable), and how close you are to a fault line. More earthquake premiums exist in California, Washington and Missouri than any other states, according to the Insurance Information Institute.

Benefits of having a local agent

With commercials and advertisement touting the benefits of buying insurance online, sometimes we forget about the advantages of having a local agent.

“It’s usually not more expensive, however if it is, it’s still worth having a local agent as they are your advocate and can help you through things like claims,” Thompson says. “It’s more challenging when all you have is an 800 number, and the people on the other line oftentimes aren’t even licensed and don’t have your best interest in mind.”

Not only is it important to work with an insurance company that has your best interest in mind, it’s also important to sit down with your agent and discuss your coverage every one to two years — especially if there’s a change to your property (new pool, trampoline, shed).

“I’d recommend homeowners review their policy at least once a year,” says Justin Ross, owner of Goosehead Insurance in Coral Springs, Florida. “Situations regarding the property or the client’s financials frequently change, and it’s important the policy properly reflects those changes and their desires.”

Items to consider including in your homeowners insurance

In addition to recommending replacement value coverage on your home and contents, insurance agents also suggest including coverage in case a sewer or water line backs up into the house (cost is nominal, around $50 a year) and possibly disability and life insurance (cost can range from $50 to $150+ depending on your age, health and coverage amount).

“Make sure that you carry higher limits of personal liability protection, at least $500,000, and make sure that personal injury is part of that coverage or added separately,” Seymour says. “Your agent will also recommend a personal umbrella policy (PUP) to give an extra layer of personal liability protection of $1 million or more over your home and automobile liability limits. Your home and your life savings are two of your most valuable assets. Protect them well.”

Have you recently made a claim on your homeowners insurance? Tell us about the experience in the comments section below.