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When you're choosing a home insurance policy, you should aim for enough coverage to protect all of your assets if your house is destroyed in a disaster or you're held liable in a lawsuit.
Generally, homeowners insurance policies cover four main areas:
- Dwelling coverage: to rebuild your home.
- Personal property coverage: to replace personal property destroyed by a covered peril.
- Liability coverage: should someone get injured on your property and sue you.
- Additional living expenses (ALE) coverage: to cover expenses if you're forced to temporarily move out of your house.
If your current policy's limits aren't enough to cover these expenses, consider purchasing additional homeowners insurance.
How much dwelling coverage do I need?
You should have enough dwelling insurance to cover the cost to rebuild your home and any attached structures, such as a garage. Remember to account for replacing built-in appliances, such as a water heater.
Your policy will include one of three levels of coverage. Unfortunately, some homeowners don't realize that their policy’s limits aren't high enough to entirely replace their homes.
|Actual cash value (ACV)||The ACV is the market value of your house, minus 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. That’s why the ACV likely won't cover the entire cost to rebuild your home with new materials.|
|Replacement cost value (RCV)||The RCV is the cost to rebuild your house at current prices for labor and materials. A policy that covers your home's RCV will have a higher price than one that covers only the ACV. RCV coverage could provide a substantial amount of additional reimbursement if you need to replace all or part of your home. However, it is still subject to policy limits.|
|Guaranteed replacement cost (GRC) and Extended replacement cost (ERC)||The GRC/ERC is like the RCV, plus 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, flooding the ground floor of your home. The wooden flooring that you installed 10 years ago for $10,000 needs 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. Also, your home insurance policy has a $1,000 deductible. An ACV policy would only reimburse you $5,000, and you'd have to pay the rest out of pocket. However, an RCV policy would reimburse you $10,000, and you'd pay only the deductible.
If you own a condo, certain elements of your home's structure, such as the walls, may be covered under the condominium master policy. Consult your master policy to determine the amount of dwelling coverage you need for your condo.
How much does dwelling insurance cost?
The amount of dwelling coverage included in your policy has a significant effect on the rate you pay. A home with $250,000 of coverage is 37% more expensive to insure than one with a $150,000 limit, and a $350,000 limit equates to a 75% increase.
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Most homeowners insurance companies require you to be insured for at least 80% of the replacement value of your home. This is known as the 80/20 rule. If you're underinsured, you'll receive less money when you file a claim.
Let's say that your home is insured for $200,000, but would cost $300,000 to rebuild. If you file a claim for $100,000, the insurance company could prorate your settlement by the percentage that you're underinsured. In this case, you would receive $67,000 minus your deductible, and you would have to pay for the remaining repairs out of pocket.
How much personal property coverage do I need?
The best way to ensure you have enough personal property coverage to replace your belongings is to put together a home inventory.
A home inventory is a detailed and comprehensive list of every item in your house. That might sound like a lot of work, but it's an important step if you want to obtain quality replacements for your items if they're destroyed by a covered loss.
We recommend you include as many details as you can about every item on your list, including:
- Name and model of each item.
- A serial number, if available.
- A description of the item.
- The cost of the item.
- A receipt with place and date of purchase, if available.
After completing your inventory, total the value of your belongings and check the total against your coverage limits.
Insurance companies often set personal property coverage limits at 75% of your dwelling coverage by default. For example, if your home is worth $200,000, then your personal property limit would be $150,000.
How much liability insurance do I need?
Personal liability insurance covers the cost of a lawsuit if you're sued for destroying someone's property or causing an injury. For that reason, the amount of assets you have dictates the amount of liability coverage you need.
For example, if your dog bites a neighbor or someone slips by your pool, you could be responsible for their medical costs. If your liability coverage limit is $100,000, but you're found liable in a $250,000 lawsuit, you would have to pay the $150,000 difference, and your personal assets could be claimed in the settlement.
How much is liability insurance?
Fortunately, liability insurance is typically one of the least expensive components of a homeowners insurance policy. The difference in price between $100,000 and $300,000 worth of liability coverage is only $18 per year, and $1 million of coverage costs as little as $5 per month.
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If you're concerned about having enough liability coverage, you can also consider purchasing an umbrella policy.
Which 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 in a company-sponsored 401(k) is exempt, and in some states, such as Florida, home equity is protected.
Assets at risk in a lawsuit
Assets that may be protected
|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 in your bank accounts|
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.
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, it’s typically 30%. So, if your policy has a $500,000 dwelling coverage limit, your ALE coverage limit would be $150,000. For 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 while your home 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 different home until your house is in a livable condition. In this case, ALE coverage may pay the following expenses, in order to provide comparable living conditions:
- Rent or hotel fees
- Gas for traveling between your house and temporary home
- Moving costs
- Food costs, if your temporary home doesn't have a kitchen
What type of insurance do I need?
Though we often refer to "homeowners insurance" generically, there are different types of homeowners insurance that offer different kinds of coverage.
- An HO-1 policy only covers damage done by a peril explicitly named in the policy. Unlike the other forms of homeowners insurance, it usually does not cover any damage to your personal belongings inside your home, only damage to the structure of the home. Additionally, it usually does not include liability coverage.
- An HO-2 policy only covers damage done by a peril explicitly named in the policy. It covers damage to your personal belongings inside your home, as well as the structure of your home.
- An HO-3 policy is the most common type of homeowners insurance. All damage done to the structure of your home is covered unless the damage was the result of a peril specifically excluded from your policy. By contrast, only some damage done to your personal property is covered. The peril that caused the damage must be specifically named in the policy.
- An HO-5 policy covers all damage to the structure of your home and your personal property unless the peril that caused the damage was specifically excluded from the policy.
- An HO-8 policy is intended for an older home with a replacement cost greater than the actual cash value of the home. It only provides coverage when damage results from a named peril.
The limited coverage an HO-1 policy provides makes it an unpopular option. Only 1.5% of homeowners insurance policies are HO-1. If you do have an HO-1 policy, however, you should consider whether you're truly comfortable paying to replace all of your possessions out of pocket and foregoing protection against a lawsuit.
We recommend an HO-3 policy for most homeowners — it offers more comprehensive protection.
Frequently asked questions
Do I need homeowners insurance?
Homeowners insurance is not federally mandated, but your mortgage lender may require you to take out a policy. We strongly recommend purchasing home insurance to protect against a catastrophic loss.
How much should homeowners insurance cost?
The average cost of home insurance is $120 per month, or $1,445 per year. Rates vary significantly based on your location, the age and type of home you own, and the coverage limits you choose.
How much condo insurance do I need?
Most lenders require you to have dwelling coverage limits of either 20% of the value of your condo or $100 per square foot for your condo.
What is extended dwelling coverage?
Extended dwelling coverage is an additional amount of coverage that an insurance company agrees to pay above the dwelling limit if your home needs to be rebuilt. For example, If your home is insured for $300,000 and you have a 25% extended dwelling coverage on your policy, the insurance company will pay up to $375,000 to rebuild your home. Many insurance companies offer this coverage as an optional policy add-on.
To compare homeowners insurance rates, we gathered thousands of quotes from ZIP codes across Texas from five of the largest insurers in the state. Quotes are based on a home built in 1977 with the following coverage limits. Dwelling and liability coverage limits were altered to calculate differences in cost by coverage amount.
|Personal property||50% of dwelling limit|
|Medical payments liability||$5,000|
|Additional living expenses||20% of dwelling limit|
This analysis used insurance rate data from Quadrant Information Services. These rates were publicly sourced from insurer filings and should be used for comparative purposes only — your own quotes may differ.