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How Home Insurance Works

Knowing how your home insurance covers you is as important as what it covers. We can help you understand how it works.

A home insurance policy is one of those assets that homeowners really need, even if it’s not required by law. Homeowners insurance covers your home’s structure, your belongings and liability issues, depending on the limits of the policy you choose. Although it may seem difficult, choosing a home insurance company and setting coverage limits is straightforward.

If something happens to your home and it’s covered under your homeowners insurance, you may need to file a claim. Your insurer can help you through the process to make sure your claim is processed correctly. After your claim is reviewed and your claim found to be covered by your policy, you’ll receive a payout for your damages. This article will cover:

What home insurance covers

A key step in understanding how your home insurance works is to understand what it covers. Basic home insurance covers:

  • The physical structure of your home
  • Personal property
  • Damages to others
  • Extra costs if you need to relocate, also known as "loss of use"

Dwelling coverage, also known as “hazard insurance”, is the portion of a home insurance policy lenders tend to be most interested in. If you bought your house through a mortgage lender or a bank, they’ll require you to have home insurance in order to protect their investment.

Do you need home insurance?

Even if home insurance isn’t required by your lender, you still should have it as financial protection. Your house is probably the biggest asset you have, and a homeowners insurance policy is the easiest, most affordable way to protect it.

How to purchase home insurance

There are various home insurance policy types depending on your specific needs. The policy you choose will describe the exact range of coverage and limits you have.

To give an example, the average payout for a fire damage claim is $79,785. Given that the average cost of home insurance is $1,215 a year, the return on investment is obvious. For a fraction of the cost of the average claim, a home insurance policy can protect you from serious financial peril.

An HO-3 policy is the most popular home insurance type. It covers the structure of your home against all perils except ones explicitly listed. It also covers your belongings against 16 named perils.

There is also the HO-5 policy. It covers both dwelling and personal property from all perils except those excluded in writing. The HO-5 is much more comprehensive than the HO-3, but it also costs more.

After comparing home insurance quotes and finding the coverage limits you need, your premium will be calculated. This rate is based on the coverage you choose, as well as other factors, including the age of your home and where it’s located.

Choosing an HO-3 policy is a good way to get decent coverage at a good price. If your budget can handle the cost of an HO-5 policy, by all means, go for it. Also, make sure to look into endorsements for perils not covered by a standard homeowners policy, such as flood or earthquake.

How your home insurance premium is paid

Your yearly premium is based in part on the coverage you request, but also other factors such as the age of your home and the area it’s located in. How it’s paid depends mostly on if you bought your home through a mortgage lender or paid cash.

If you purchased your home with a mortgage, your home insurance premium is in your mortgage payment that you pay monthly. If you bought your house outright, you can pay your insurance company directly either with a single annual payment or in monthly payments.

How are homeowners insurance claims filed?

When your home is damaged, you would first check your policy to make sure the damage isn’t caused by an excluded peril. If the source of damage is covered by your home insurance, contact your home insurance company. They will initiate the home insurance claim process for you.

In some cases, your home insurer will send an adjuster to your home to assess the damage. Your insurance provider will then look at your policy to see what your coverage limits are and read the adjuster’s report. Once they have assessed your claim, they will arrange for your payout.

How your home insurance claim gets paid out

Your home insurance policy pays out claims depending on if you chose replacement cost or actual cash value (ACV). Replacement cost pays out on claims at the amount needed to replace covered items. ACV pays claims at the depreciated value of the item. For example, if your two-year-old television with a life span of five years is destroyed in a fire, an ACV home insurance policy will pay out for about 60% of the cost to replace it.

The final payout on your claim will also have your deductible subtracted from it. The deductible is the amount you agree to pay before your home insurer pays the remainder of the claim.

In order to avoid insurance fraud and to encourage policyholders to use claim money to actually buy the necessary replacements, home insurers will often cut you a check for the ACV of the damaged or destroyed item. They will then pay you the remainder owed once you provide receipts showing the replacement item has been purchased.

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