While not federally mandated to do so, your mortgage lender may require you to take out a homeowners insurance policy, and we strongly recommend that you purchase one in order to protect yourself from the high costs associated with a home loss. You should aim to have sufficient home insurance to cover all of your assets should your house be destroyed in a disaster or you be held liable in an injury lawsuit. Generally, homeowners insurance policies provide four main areas of coverage:
- Dwelling coverage: to rebuild the structure of your home
- Personal property coverage: to replace personal property destroyed within the home
- Liability coverage: should someone get injured on your property and choose to sue
- Additional living expenses (ALE) coverage: to cover additional living expenses if you're forced to temporarily move out of your house
If your current policy's limits aren't enough to cover each of the above expenses, you should consider purchasing additional homeowners insurance.
How Much Dwelling Coverage Do I Need?
You should have sufficient dwelling insurance to cover the cost of rebuilding your home and any attached structures, such as a garage, if they're destroyed due to a covered peril. You also need to account for the cost of replacing built-in appliances, such as a water heater, when determining your dwelling coverage needs.
If you own a condo, certain elements of your dwelling's structure, such as your walls, may or may not fall under the condominium master policy. Consult your master policy to determine what structures you're responsible for insuring.
Your policy will include one of three levels of coverage. Unfortunately, some homeowners don't realize that their current policies' limits aren't high enough to entirely replace their homes.
|Actual Cash Value (ACV)||The ACV is the market value of your house, minus any depreciation. While the value of your land may have increased since you bought it, specific elements of your house, such as the roof, plumbing or floorboards, have aged, and therefore may have depreciated in value. Because of this, the ACV likely won't cover the entire cost to rebuild your home with new materials.|
|Replacement Cost Value (RCV)||The RCV is the amount it will cost to rebuild your house at the current prices for labor and materials. A policy that covers your home's RCV will have higher premiums than one that covers only the ACV. RCV coverage could provide a substantial amount of additional reimbursement if you need to replace all or a part of your home. However, a policy that covers the RCV is still subject to policy limits.|
|Guaranteed Replacement Cost (GRC) / Extended Replacement Cost (ERC)||The GRC/ERC is like the RCV, but with a guarantee that the insurance company will pay a certain percentage beyond your policy's limits to rebuild your home. This is relevant if a regional disaster temporarily drives up the cost of labor and building materials. However, this is the most expensive option.|
For example, say your pipes burst and flood the ground floor of your home. The wooden flooring that you had installed 10 years ago for $10,000 will need to be totally replaced. The insurance adjuster estimates that with 10 years of wear and tear, the current ACV of your flooring is only $6,000, and new flooring will cost $11,000 based on your house's square footage. Also, your home insurance policy is subject to a $1,000 deductible. If you have an ACV policy, your insurance company would only reimburse you for $5,000 of the cost, and you'd have to pay for the rest out of pocket. However, if you opted for a policy that covers the RCV of your home, your insurer would reimburse you $10,000, and you'd be responsible only for the deductible.
How Much Personal Property Coverage Do I Need?
The personal property clause of your homeowners insurance policy needs to have a high enough limit to replace all of your possessions if they're stolen or destroyed in a disaster. Virtually all of your personal possessions are covered by this clause, with one notable exception—your car. Even if it's parked in your garage, your vehicle needs to be insured by a comprehensive policy in order to be protected against theft, fire, or other disasters.
Generally, home insurance companies will set the default proportion of personal property insurance at 75% of your dwelling coverage. So if your house's RCV is $500,000, then your personal property limit will be set at $375,000. Whether this default amount is suitable to your needs depends on the total value of your possessions. While it may seem like a lot of work, taking an inventory of everything you own will help you more accurately estimate your property coverage needs. It will also make filing a claim much easier in the future should your property be destroyed.
Start with the large items: TVs, computers, fridges, couches, beds. Estimate how much you spent on each of those items, and how much it would cost to replace them now. Then tally the smaller things: clothes, kitchen appliances, tools, sports equipment, and the like. Once you have an estimate of the value of everything you own, compare it to your home insurance policy's default coverage amount. If your current coverage is less or more than you need, talk to your insurer to change your limits.
Finally, check your homeowners insurance policy to determine if there are any item-specific limits relevant to you. For example, most standard policies will cover fur and jewelry only up to $2,000. If the total value of any relevant items you own exceed this limit, you will need to purchase a separate endorsement or policy to increase your coverage amount.
How Much Liability Coverage Do I Need?
The more assets you have and the more at risk of being sued you are, the more liability coverage you need. The liability section of your homeowners insurance policy is meant to protect you if someone is injured on your property and decides to file a lawsuit. For example, if your dog bites a neighbor, or if someone slips and falls by your pool, you could be held liable for any medical costs incurred by their injury. If your current liability coverage limit is $100,000, but someone sues you for $250,000, you would be responsible for the $150,000 difference, and your personal assets could be claimed in the settlement.
What Assets Are at Risk in a Lawsuit?
Most of your possessions—such as money in a bank account or your vehicle—are at risk if someone tries to sue you and you don't have adequate insurance. However, some assets, such as retirement funds, are exempt from lawsuits. Under the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), both Roth and traditional IRAs are protected up to $1 million combined, and this amount is adjusted for inflation every three years. SEP IRAs, SIMPLE IRAs and most rollover IRAs are fully protected from creditors in a bankruptcy, up to any amount. Additionally, money stored in a company-sponsored 401(k) account is exempt, and in some states, such as Florida, home equity is protected.
However, each state has different legislation regarding how insulated your retirement funds are from a lawsuit, so you should review your state's laws to determine what is at risk. For example, in California, IRAs do not have the same level of protection as money stored in a 401(k). So California residents may need to include at least some of their IRA investments in their estimate of their total at-risk assets.
|Assets at Risk in a Lawsuit||Assets That May Be Protected from a Lawsuit|
|Vehicles titled in your name||401(k)s|
|Business assets that you personally own||Annuities|
|Non-dwelling real estate||Home equity|
|Future wages||Social Security benefits|
|Money that you have in your bank accounts|
Fortunately, liability insurance is typically one of the least expensive components of a homeowners insurance policy. The difference in premiums between $100,000 and $500,000 worth of liability coverage is often very small, so you should strongly consider choosing higher limits on your policy. Below you can see how much different liability limits cost at State Farm.
|Liability Amount||State Farm Total Monthly Rate|
If your total assets exceed the limit of your homeowners policy's liability clause, you can also consider purchasing an umbrella policy to provide coverage beyond those limits. For example, consider if someone files a lawsuit against you for $750,000, and your home insurance policy has a $500,000 limit. Normally, you'd be responsible for the $250,000 that exceeds your liability coverage limit. But if you have an umbrella policy that provides $1 million in insurance, it will cover the difference.
How Much Additional Living Expenses Coverage Do I Need?
Most insurers set your additional living expenses (ALE) coverage at a fixed percentage of your total dwelling coverage amount. For standard homeowners insurance policies and renters insurance policies, the limit is typically 30% of your dwelling coverage limit. So, if your policy has a $500,000 dwelling coverage limit, your ALE coverage limit would be $150,000. However, if you own a condo, your ALE coverage amount may be up to 50% of your dwelling coverage limit.
ALE coverage can be critical if you're temporarily displaced from your home while it is being repaired. For example, if your house is damaged in a fire, and it will take two months to repair, you'll have to rent a new home until your house is in a livable condition. In this case, ALE coverage may cover the following expenses, in order to provide comparable living conditions:
- Rent or hotel fees
- Gas expenses from traveling between your house and temporary home
- Moving costs
- Food costs, if your temporary home doesn't have a kitchen
How Much Homeowners Insurance Should I Have Based on My State?
We compiled the median home values in each state, as well as the property damage done to the state per square mile in the last 60 years. If your state tends to see higher property damage costs, such as California or Louisiana, you should consider choosing GRC/ERC coverage for your homeowners insurance policy.
|State||Median House Value||Property Damage Per Square Mile|