Updated: Jan 29
One of the final steps before closing on the purchase of property is obtaining property insurance. If the purchase is financed by a loan, the lender will require the property to have adequate property insurance to protect the lender’s interest. In addition, most investors who purchase property for cash obtain property insurance before completing the closing in order to protect their investment. Many first-time homebuyers are confused about why they need to obtain property insurance and what property insurance covers and does not cover. This article provides basic answers to common questions about property insurance.
What is property insurance? Property insurance is a series of policies or a single policy with multiple coverages to protect the property owner from loss if their property is damaged or destroyed and provide coverage for the property owner’s liability. If the property is damaged or stolen or someone is injured on the property, the property insurance will repair or replace the property or pay the claim of the person who was injured on the property.
The categories of property insurance include homeowner’s insurance, renter’s insurance, flood insurance, earthquake insurance, and personal property coverage among other policies. If the property is damaged or lost, the property insurance policy will reimburse the policyholder for the actual value of the damage or loss. For people whose only property investment is their home, homeowner’s insurance may be the only type of property insurance they ever need. Homeowner’s insurance protects your home and possessions against damage or theft. All mortgage companies require their borrowers to have homeowner’s insurance coverage in an amount equal to the replacement value of the home and require that the insurance also cover the mortgage company so that the mortgage is paid in the event of a loss.
It is important to know what types of loss or damage are covered and what types of loss or damage are not covered by property insurance. Property insurance typically covers losses or damages caused by severe weather events, such as hurricanes, floods, snow, hail or lightning, or from accidents and incidents beyond the owner’s control, such as fire, vandalism, and theft. In the event the owner’s home or possessions (if covered by the policy) are damaged or destroyed as a result of a covered event, the insurance company will compensate the homeowner so that their house can be repaired or even completely rebuilt and their personal property repaired or replaced. Most property insurance also covers the homeowner from liability if someone other than the homeowner is injured on the property.
Most homeowner policies include some amount of coverage for furniture, appliances, clothing and other personal property in the home that may be damaged or destroyed in an insured event. Property insurance does not cover the damage that results from normal wear and tear to property or to replace systems or appliances that break down, though there are some separate insurance programs that are available to cover some costs for appliance and building system repairs for a limited period of time.
In some cases, property insurance may not cover or have limited coverage or higher deductibles for certain events, such as sinkholes, floods, earthquakes, nuclear events, acts of war or terrorism and mold. It is important to review your policy and determine what coverages are provided or excluded and determine whether it is appropriate to purchase additional coverage for these events if such coverage is available. However, if you are in an area that is prone to floods, earthquakes or hurricanes, there may be an extra charge to obtain these insurance coverages. There may also be additional coverages that you can add on to the policy or obtain through a separate policy, such as sewer and drain back up coverage or even identity theft coverage.
Most insurance policies have deductibles that require the homeowner to pay a portion of the loss before the insurance company pays the rest of the loss. It can be either a dollar amount, such as the first $500, or a percentage of the policy amount, such as 3% of the policy amount for hurricane damage.
There are three types of property insurance coverage: replacement cost, actual cash value, and extended replacement costs.
Replacement Cost covers the cost of repairing or replacing property up to the original condition without deduction for depreciation. The coverage is based upon replacement cost value rather than the current cash value of items. In simplest terms, if a 55-inch television is destroyed, the homeowner is provided enough funds to purchase a new 55-inch television.
Actual Cash Value coverage pays the owner or renter the replacement cost minus depreciation. If the destroyed item is a certain number of years old, you get an amount equal to the current value of the item, not a new one. If a 55-inch television is destroyed, the homeowner gets the current value of the television based upon its age, features and expected remaining useful life. In some instances, an item that was still functioning may have very little actual cash value.
Extended Replacement Cost will pay more than the coverage limit to repair or replace the property if the costs for construction of the property have gone up; however, the additional cost that the insurance company must pay is usually capped at an additional 25% over and above the insurance coverage amount.
In addition to the overall insurance amount, the insurance policy will often include limitations on the maximum amount that the insurance company will pay to cover a given situation or occurrence. For example, there are limits on the amount of coverage provided for personal property damage or to remediate mold. According to the insurance information institute, most insurance companies will provide personal property coverage for 50-70% of the amount of insurance you have on the structure of your home. If your house is insured for $100,000, there would be up to about $70,000 worth of coverage for your possessions.
While insurers compensate for your claims, they also intend to make money. Insuring a home that has had multiple claims in the past three to seven years, even if a previous owner filed the claims, can result in higher insurance premiums for the home.
The neighborhood in which the home is located and the general availability and costs of construction labor and building materials in the community also impact the insurance rates. The coverage of options like higher or lower deductibles or added riders to provide higher amounts of coverage for valuable art, antique furniture, jewelry, etc. will also factor into the size of an annual premium. Pricing and eligibility for property insurance can also vary depending on an insurer’s preference for certain building designs, roof type, condition or age of the home, type of heating system, the proximity to the coast, swimming pools, trampoline, security systems and more. Typically, wood-frame structures will cost more to insure than cement or steel-framed structures because wood-framed structures are more likely to be damaged by fire and adverse weather conditions.
Most homeowners purchase a hybrid insurance policy that compensates for physical loss or damage caused by 16 listed perils. This coverage is commonly referred to as an HO-3 policy. You may also find some insurance companies offer HO-1 and HO-2 forms, which provide homeowners very basic levels of coverage. Compared to an HO-3 policy, an HO-1 policy excludes the coverage for damage from falling objects, including trees, the weight of ice, snow or sleet and provides no coverage for flood damage. HO-2 provides broader coverage than HO-1, but less coverage than an HO-3. HO-2 covers the damage caused by the perils specifically listed in the policy form. An HO-5 policy includes everything in an HO-3 policy, including coverage for furniture, appliances, clothing, and other personal items. HO-5 does not cover earthquakes and floods. The difference between HO-3 and HO-5 is that HO-5 provides more extensive coverage or your personal belongings and the dwelling. There is also HO-4 property insurance, known as renter’s insurance, which is the only type of policy tenants can purchase. The HO-4 covers tenants from loss of personal property and liability. The house or apartment being rented will be covered by the landlord’s insurance policy. In addition, HO-6 and HO-B policies provide specific coverages for condominiums or properties in coastal areas.
Property insurance is necessary and beneficial to protect homeowners from loss or damage to their property or liability claims. Purchasing home insurance requires research and some homework to become familiar with the items covered by the insurance policy and to check the insurance company’s financial stability, claims response policies and policyholders’ satisfaction. In obtaining home insurance, be sure to review the proposed coverages, deductibles and premium quotes carefully, get multiple quotes and select the coverage that best suits your needs.