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Homeowners Insurance: A Simple First-Time Buyers Guide

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Homeowners insurance is an insurance policy that pays out cash when a home is damaged by weather, or fire, or other means.

When you buy your dream home and mortgage it, you’re acquiring the largest asset of your life and also your largest debt.

For your protection, there’s homeowners insurance.

How Does Homeowners Insurance Work?

Lenders require homeowners insurance on every home with a mortgage because when your home is damaged, it’s not just you who takes the loss. Your lender loses, too.

Homeowners insurance is also known as hazard insurance.

Insurance helps pay for repairs and replacements after a disaster. It restores homes to their original, full market value.

Imagine a storm causes damage to your home. A falling tree crashes through your roof. You call a roofing repair company and it assesses the damage at $1,000.

You file a claim with your insurance company.

  • If your deductible is $250, the insurance company sends you $750 for repairs
  • If your deductible is $500, the insurance company sends you $500 for repairs
  • If your deductible is $1,000, the insurance company send you nothing

Do You Need Homeowners Insurance?

Imagine if you didn’t have insurance, and your roof sprung a leak. Could you immediately pay for repairs from your savings? How would that affect your budget?

Or, what if you delayed repairs for a few months while you built up sufficient reserves? What other damage might occur to your home because of the leak, and how might that cause your home’s value to drop?

Scenarios such as this are why mortgage lenders require home buyers to carry homeowners insurance. With insurance, repairs can be made immediately.

Homeowners insurance does more than protect your asset — it also protects your debt.

What Is a Homeowners Insurance Deductible?

A deductible is the amount of money that an insurance company withholds when paying a homeowner’s insurance claim.

Deductibles are designed to reduce moral hazard, such as a homeowner deciding not to install smoke alarms because “insurance will pay for the damage,” or not installing a home security system because “insurance will pay for anything stolen.”

Homeowners choose the size of their insurance deductible. When you choose a larger deductible, the cost of your homeowners insurance policy drops because your insurer pays less money for damages and claims.

Deductibles apply to all of the insurance types you might use as a homeowner: homeowners, auto, earthquake, flood, and umbrella insurance.

How Much Should My Homeowners Insurance Deductible Be?

The three most common homeowners insurance deductible sizes are:

  • $250
  • $500
  • $1,000

$250 Deductible: When you live paycheck-to-paycheck and don’t have much savings

When you choose a $250 deductible, your out-of-pocket costs stop at $250 after a loss that requires an insurance claim.

Your insurance company covers your loss, minus the $250 that represents your deductible.

Choosing a $250 deductible works for people who have little or no money left at the end of a month, and whose bank accounts aren’t as large as they’d like.

The trade-off of a smaller-sized deductible: higher monthly premiums.

An insurance plan with a $250 deductible may cost 20 percent more than a larger-deductible plan. So, choose a higher deductible amount if you can afford to pay more than $250 out-of-pocket after an accident or a loss.

Otherwise, the $250 deductible works great.

$500 Deductible: When you’re getting by and have some money saved up

When you choose your insurance company’s $500 deductible option, your insurance company caps your out-of-pocket costs to repair, replace, or remedy at $500.

Your insurance company pays for damages in full, minus your $500 deductible.

Choosing a $500 deductible is good for people who are getting by and have at least some money in the bank – either sitting in an emergency fund or saved up for something else.

The benefit of choosing a higher deductible is that your insurance policy costs less.

So, if you feel good about your cash savings and can reasonably make $500 payment after an accident or loss, choose the $500 deductible.

$1,000 Deductible: When you’re living comfortably and feel good about your savings

Choosing the $1,000 deductible option limits your out-of-pocket costs after an insurance claim to $1,000. Your insurance company pays all of your damages – minus your $1,000 deductible.

The $1,000 deductible is good for people who earn a healthy income and who have sufficient savings to handle unexpected events, such as car accidents, damages to the home, and the theft of valuables.

Choosing a $1,000 deductible lowers your policy costs considerably. High-deductible insurance costs at least 20 percent less when compared to low-deductible policies.

Just make sure you have at least $1,000 available in savings at all time.

Does Homeowners Insurance Include Flood Insurance?

Flood damage is specifically excluded from ordinary homeowners insurance and renters insurance policies. To file a legitimate claim, separate flood insurance coverage is required.

A flood insurance pays for:

  1. Repairs to the inside of a home that’s been damaged by floodwaters
  2. Replacements for personal property inside a home that’s been damaged by floodwaters

Insurance companies are specific about “what qualifies as a flood.”

In insurance terms, a flood is when two or more homes are damaged by water; and where the water has come from any of the following: an overflowing natural body of water, a mudflow, or heavy rain that overwhelmed the ground’s ability to handle natural water run-off.

Flood insurance pays to fix electrical and plumbing systems in your home; replace appliances and heating and cooling systems; replace the carpeting and hardwood flooring; and, haul debris.

It also pays for damages to wardrobes, furniture, and electronics.

Floods cause more damage in the United States than any other weather-related event and all 50 states have experienced floods in recent years.

Depending on where you live, flood insurance can be cheap. It can be even cheaper when you bundle it with your other insurance coverages, such as homeowners and auto insurance.

Homeowners Insurance vs Umbrella Insurance?

Umbrella insurance is a generic term for insurance that covers “everything else”.

You may know umbrella insurance by another, more specific name.

  • Excess Liability Policy
  • Personal Liability Insurance
  • Personal Liability Umbrella Insurance
  • Personal Umbrella Policy

For homeowners, umbrella insurance is a must.

Umbrella insurance kicks in where your homeowners insurance and auto insurance coverage caps out. It pays cash to protect you from the injuries you cause to others.

It also protects against excessive property damage; and from lawsuits filed against you for injury or death, which can easily exceed $1,000,000.

Umbrella insurance protects against bankruptcy.

Common umbrella insurance claims include:

  • Your dog injures a guest in your home
  • An injury caused by a babysitter’s negligence
  • A non-family member breaks a bone on your backyard trampoline

Umbrella insurance also pays on damages awarded in a courtroom which means it’s protection against wage garnishment, which is a mandatory paycheck deduction used to pay debt.

When you buy your house, you’ll purchase homeowners insurance to cover your home. At the same time, purchase an accompanying umbrella insurance policy.

Umbrella policies are inexpensive. They protect the money you have today, and the money you’ll earn tomorrow. Policies of $1,000,000 are relatively cheap.

Flood insurance is an insurance policy. It pays cash when water enters a home from the outside, then damages property on the inside.

Get pre-approved for a mortgage today.

Dan Green
Dan Green

Dan Green is a former mortgage loan officer and an industry expert. He's appeared on NPR and CNBC, and in The Wall Street Journal, Bloomberg, and dozens of local newspapers. Dan has helped millions of first-time home buyers get educated on mortgages, real estate, and personal finance. Have mortgage questions? Ask Dan in the chat.

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