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What Is Homeowners Insurance and How Does It Work?

Dana George
By: Dana George

Our Mortgages Expert

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No matter where you live, peril can damage your home. If you have a mortgage or home equity loan balance, your lender will require you to protect your home by carrying homeowners insurance. Here, we'll cover how homeowners insurance works, the different types of coverage, and why it's important to carry homeowners insurance, even if you own your property free and clear.

What is homeowners insurance?

One of the things any good beginner's guide to mortgages covers is homeowners insurance. That's because homeowners insurance protects your investment. If there's a fire, tornado, or theft, homeowners insurance covers the losses and helps make you financially whole.

Homeowners insurance even helps cover costs if a visitor to your home is injured, or if you damage someone else's property. Let's say a friend helps you cut branches from a tree in your backyard. The ladder slips, and your friend falls and breaks his leg. The branch he was cutting crashes down, tearing down a section of your neighbor's privacy fence. The liability coverage provided by homeowners insurance can help pay your friend's medical expenses and repair the neighbor's fence.

Who needs homeowners insurance?

Every homeowner who does not want to pay out of pocket if calamity strikes needs home insurance. The only homeowners who can consider going without coverage are those who own their property free and clear. However, failing to keep homeowners insurance means risking paying for expensive repairs. If a thunderstorm destroys the roof and a homeowner lacks coverage, the homeowner has to pay to repair the roof.

Homeowners insurance is not private mortgage insurance (PMI). PMI is carried by home buyers who put less than 20% down on a property purchase. It protects the lender if the homeowner defaults on their monthly mortgage payments. While PMI is strictly to cover the lender, homeowners insurance covers homeowners, protecting them from high repair and replacement expenses.

Is homeowners insurance required?

Yes. If you carry a mortgage or have a home equity loan or home equity line of credit (HELOC), your lender requires that you have home insurance coverage. That's because your property acts as collateral for these types of loans. As a result, the lender wants to make sure your home is in good shape. If you fail to make payments as promised, the lender can legally take possession of this collateral (your home), then sell it to recoup losses.

Types of homeowners insurance

The homeowners coverage you choose depends, in part, on where you live and the kinds of natural disasters your home is most likely to experience. It also depends on the type of home you own.

Different types of coverage are broken down into standardized levels, referred to as HO-1 through HO-8. Each level covers something different. Your home insurance company can help you decide which type of policy gives you the greatest coverage at the lowest cost.


HO-1 is the most basic form of home insurance, typically covering 10 potential perils. Due to its limited coverage, some insurers no longer offer this type of policy.


Like HO-1, but with broader coverage.


HO-3 is the most common type of homeowners insurance. It provides "open peril" coverage, meaning it covers repairs to your home damaged by any catastrophe not explicitly listed as an exclusion.


HO-4 is renters insurance coverage. Renters insurance is essential for some of the same reasons a home insurance policy is important. Renters insurance should be a priority for any renter who wishes to protect their personal belongings.


HO-5 is perfect for homeowners who want to cover all their bases. It covers several perils excluded from other policies, including things like war, nuclear hazard, earth movement, and mechanical breakdown.


HO-6 is written for condo coverage, and is sometimes referred to as "walls-in" coverage. It covers issues inside the walls of the unit, as well as personal belongings. Typically, a condo association has its own policy to protect the building and common areas, while condo insurance protects your unit and personal possessions.


HO-7 covers mobile homes, protecting the physical structure and personal property.


HO-8 policies are designed to cover older, historic homes. Rather than pay replacement costs, they provide cash value. For example, if the entire roof is damaged, this policy type pays what the roof was "worth" when damaged. The insured pays any difference in the cost to have the roof replaced.

What's covered by homeowners insurance?

What's covered by homeowners insurance is a bit of a trick question. Homeowners can buy a basic, stripped-down policy or opt for more comprehensive coverage. Generally, the more that is covered, the more expensive the policy.

Let's look at what is covered with an HO-3 policy, the most common type:

Dwelling: This policy protects your home and any other structure on your property. For example, if you have a shed, detached garage, or fence, an HO-3 policy covers it against damage.

Personal property: Let's say your home burns to the ground. Personal property coverage pays to replace the contents of your home, garage, shed, or other outbuildings. The price of your policy is impacted by how much coverage you need.

Liability: Remember that imaginary friend who came by to help you cut branches and fell from a ladder? Liability insurance covers his medical expenses and lost wages. If he sues you, it covers your legal expenses. And if he dies, it pays his family death benefits. In short, this coverage protects you from expensive personal liability.

Optional coverage: Let's say you live near a river that overflows whenever it rains. You may want to add flood insurance to your homeowners coverage. Covering water backup from a sewer may also be a good idea. Suppose you live near an earthquake fault line. Earthquake coverage can help you rebuild. Opting for replacement cost rather than cash-value insurance can give you peace of mind that if anything goes wrong, your property will be repaired or replaced. Don't forget about any other structures that may not be covered in a standard homeowners policy. For example, if you have any of these, ask about the cost of adding them to your policy:

  • Gazebo
  • Pool
  • Tennis court
  • Other uncovered structure

What's not covered by homeowners insurance?

Coverage varies, but a typical home insurance company excludes these perils:

  • Injuries purposefully inflicted on yourself or others
  • Floods
  • Mudslides
  • Some wind damage
  • Mold damage
  • Insect damage
  • Sewer backups
  • Government seizures
  • Earthquakes
  • Dog bites
  • Power failure
  • Acts of war
  • Faulty workmanship

This list is by no means comprehensive. It is just as important to learn what is not included in a homeowners policy as it is to know what's included. That way, you can ask your agent about adding additional coverage.

How much does homeowners insurance cost?

The average cost of homeowners insurance is $2,305 annually. How much you pay depends on many factors, including:

  • Size of the home
  • the property's location
  • If you opt for extra coverage
  • If a dog lives on the premises
  • Whether you have a pool or trampoline
  • How near you live to a fire station
  • If you run a business on the property

How much homeowners insurance do you need?

An insurance agent can help you figure out how much home insurance you need, although much depends on your comfort level. Make sure you have enough to:

  • Rebuild your home, including any outbuildings
  • Provide replacement cost coverage so that everything can be put back like it was before the event
  • Cover injuries that occur on the property, protecting you from personal liability
  • Pay for the additional living expense of being out of the home during rebuilding or repair
  • Give you peace of mind that you won't empty your savings account to cover losses

What to look for in a homeowners insurance policy

The perfect homeowners insurance for you provides these four things:

  1. The greatest amount of coverage at the lowest price
  2. An insurer who provides strong customer service
  3. Options to save money by bundling, like combining home insurance and auto insurance
  4. An insurance agent willing to review your coverage with you each year to ensure that you have what you need

If your goal is to buy a home soon, this mortgage calculator can help you determine how much you can afford. Once you have that number, add in all your monthly expenses (including taxes and homeowners insurance) and make sure you won't come up short. Life is more fun when you have a little left over each month to do the things you enjoy.

Ready for the next step? Check out our guide on How to Get Homeowners Insurance.

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