The Insurance Information Institute reports that the average cost of home insurance per year is right around $600. When you think of all the unnecessary things you buy throughout the year, probably costing far more than $600, that doesn't sound like too bad of a deal, does it?
Your home is probably the biggest investment you'll ever make, and unlike a mutual fund, it involves much more than your money. Your home is where you live, and it's a part of who you are. It's where you should feel safe and able to escape from the world. It's the place that holds the people and things that are most important to you and where you can put aside pretenses and impressions and just be yourself.
If your mutual fund takes a nosedive, you lose money. If your house burns down, however, you lose much, much more. To protect your home, you buy homeowners insurance. Although homeowners insurance can't replace your wedding pictures and the antique clock that belonged to your great-grandmother in the event of a fire or other catastrophe, it can at least enable you to rebuild your home and make a new start. It can't protect your emotional investment in your home, but it can protect your financial one.
The question, then, is how much of this insurance should you have? What kind? What should you do about deductibles? Exactly what will it cover?
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Homeowners insurance covers your home and its contents against perils. Perils is the insurance industry's word for every bad thing that could possibly happen. Homeowners insurance includes personal property coverage for the contents of your home and liability insurance for the damage you do to other people and other people's property.
Briefly, most insurance companies offer six basic types of homeowners policies. They're known in the industry as HO-1 through HO-6, and they cover a variety of different perils, or potential dangers. Some of the perils covered under the six basic policies are fire, damage caused by falling objects, an explosion in your heater or air conditioner, riots, vandalism, and hurricanes. There are also expanded versions of these policies, such as HO-3000, and they're all based on various coverages that different people need.
The perils covered under any of the six policies might vary from insurer to insurer and from state to state. For instance, in Pennsylvania, damage to your home from wind is covered under your normal policy. But in Texas, which is considered a high-risk tornado area, wind damage is not covered under the normal policy; you need additional coverage.
In addition, not all insurers offer every type of policy. That's why it's so important to know exactly what your policy covers and doesn't cover. Be sure to ask your agent to explain the entire policy, and don't be afraid to ask questions.
How Much Homeowners Insurance Do You Need?
Homeowners insurance is designed to repair or replace your primary residence if it's somehow damaged or destroyed. Coverage usually is based on the sale price of the home when purchased, but remember that the sale price includes the value of the land. If your entire property is valued at, say, $175,000, but your house would cost only $85,000 to rebuild, then you don't need homeowners insurance based on the entire value.
The part of your homeowners insurance that covers your house (the structure, that is) is called dwelling coverage. Dwelling coverage isn't based on how much you paid for your house or how much money you borrowed to buy it. It's based on how much it would cost you to rebuild your house if it were completely destroyed.
The cost to rebuild is normally based on the square footage of your home, the type of home you have, and when it was built. If you have an older home with lots of details, such as a wooden staircase, stained glass above the doors, or ornate plaster work, your insurer is likely to tell you that that sort of detail could not be matched if your house had to be replaced. You can expect to pay more for your homeowners insurance ifyou have a lot of “extras” in your home, such as garbage disposals, ceiling fans, spas, French doors, fireplaces, and so forth.
Dollars and Sense
We can't stress enough how important it is for you to closely examine your insurance policies and know exactly what coverages you have and don't have. It can be financially devastating to assume you're covered for something, only to find out after a catastrophe that you're not.
Look for a Guaranteed Replacement Provision
If your home costs more to rebuild than the limits of your insurance policy, what will you do? Pay the extra yourself, or leave your home unfinished? Some insurance policies pay off your mortgage if your home is destroyed, but don't pay to rebuild the home. Or they'll pay you the amount of your policy coverage, but not the replacement amount for your home. Guess you could always pitch a tent on that lot you own.
If you have a guaranteed replacement provision, you won't have to pay for construction, leave your home unfinished, or pitch that tent; the insurance company will pay for the rebuilding, even if it ends up costing more than your policy limits. Most insurers will give you up to a certain amount more than your policy's limits. For example, if it costs $150,000 to rebuild your home, and your policy limit is $100,000, your insurer might give you 25 percent over your limit. That means you'd get an extra $25,000, but you'd still be $25,000 short of the actual construction costs.
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The part of your homeowners insurance that covers the structure in which you live is called dwelling coverage. If that structure is damaged, and your policy has a guaranteed replacement provision, the insurance company will pay for the rebuilding, even if it ends up costing more than your limits.
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A rider on an insurance policy is extra coverage added to your basic policy. An inflation rider is a rider specifically designated to cover the increased costs due to inflation (increased cost of living).
To make sure that your replacement cost provision will truly cover the full cost of rebuilding your home, your policy must provide coverage for the entire amount of the coverage you need. If your home is valued at $100,000, and your policy's limit is $50,000, you're underinsured. What you want in your coverage is a policy that guarantees the cost of construction, regardless of whether it costs $100,000, $150,000, or $200,000 to rebuild your current home.
There's a lot to think about regarding replacement cost provisions, but they're definitely worth paying extra for. You should have a replacement cost provision to cover your personal property, as well. Be aware, however, that the definition of guaranteed replacement cost varies from insurer to insurer. Be sure to clarify your guaranteed replacement cost coverage with your insurer.