Homeowners Insurance: What Is It, How It Works

Homeowners insurance can help you pay for repairs and damage to your home's structure and replace your personal belongings in the event of a covered loss. Common losses covered by homeowners insurance include fire, hail, hurricane damage, lightning, theft, and vandalism.

Homeowners insurance also often includes certain liability coverage, which can help you pay for legal fees if someone is injured or sustains property damage at the hands of you or your family.

There are many important exceptions and other considerations when shopping for homeowners insurance. Our all-inclusive guide covers everything you need to know.

How homeowners insurance works

Like most other forms of insurance, policyholders pay a premium, usually monthly or annually, towards their homeowner's policy. The policy provides pre-agreed amounts of coverage that the insurance company will pay out in the event of a covered loss—minus any deductible that might apply. A deductible is the amount you pay out of pocket before insurance coverage kicks in.

Say, for example, you have an Allstate Home Insurance policy. The amount of your monthly premium will depend on a wide range of specifics including the size, age, location, and repair level of your home, along with the level of coverage and the size of the deductibles you choose.

Let's say your policy costs $146 per month, which is about the average in the U.S. per data from Policygenius. Your plan covers the physical structure of your home up to $300,000, as well as up to $300,000 in liability coverage, with a $1,000 deductible. This is reassuring because a big storm just rolled through your town and a tree fell on your home.

You file a claim, which Allstate would verify before paying out—minus your $1,000 deductible. Let’s say the total damage costs $50,000 to repair. Instead of being out $50,000, you’re only out $1,000, while Allstate covers the other $49,000.

In short, homeowners insurance gives you peace of mind for life’s unexpected accidents. While coverage is not legally mandated in any state, most mortgage lenders do require it.

Let’s take a closer look at the specifics.

Types of homeowners insurance policies

There are eight types of homeowners insurance policies in total, creatively named HO-1, HO-2, HO-3, all the way up through HO-8.

HO-1 is known as “basic form” homeowners insurance and offers the most limited coverage. HO-5 is the most comprehensive form of coverage for most homeowners (and, indeed, is known as “comprehensive form” coverage). Policies HO-6, HO-7, and HO-8 are designed for condominiums, mobile homes, and vintage or historic homes, respectively. While we’re at it, HO-4 is another policy type you probably won’t need as a homeowner—it’s also known as renters insurance.

The most common type of homeowners insurance is HO-3, but we’ll look more closely at the four types most likely to apply to you as a homeowner.

HO-1: Basic form homeowners insurance coverage

As we said, HO-1 is the most limited form of homeowners insurance coverage available. In fact, it can be difficult to even find such a policy for sale today. It covers dwelling and property damage due to 10 specifically named perils up to the actual cash value of your home or belongings. Most other policies offer dwelling coverage up to the replacement cost, which is helpful when you’re trying to, well, replace it.

The 10 named perils are:

• Fire damage, including due to lightning.
• Windstorm or hail damage.
• Explosion damage.
• Damages due to a riot or civil commotion.
• Damage due to aircraft.
• Damage due to other vehicles.
• Smoke damage.
• Vandalism.
• Theft.
• Damage due to falling objects.

An HO-1 plan typically doesn't offer any liability coverage, and most lenders won’t accept it as a viable form of homeowners insurance.

HO-2: Broad form homeowners insurance coverage

Broad form homeowners insurance covers more than an HO-1 policy but less than the standard HO-3 plan. Still, HO-2 plans are a bit more common than HO-1s and may be available from your insurer.

This form of homeowners insurance covers the physical structure of your home up to its replacement cost value, including unattached structures, as well as your personal property, liability and related medical payments, and additional living expenses (also known as ALE) if you should need to temporarily relocate while your home is being repaired.

Along with the 10 named perils above, broad form homeowners insurance also covers:

• Damage due to the weight of snow, ice, or sleet.
• Damage due to the accidental discharge or overflow of water or steam.
• Sudden, accidental damage to built-in appliances like water heaters and centralized HVAC systems.
• Freeze damage.
• Sudden, accidental damage due to power surges.
• Damages due to a volcanic eruption.

HO-3: Special form homeowners insurance coverage

Despite its “special” name, HO-3 coverage is considered standard nowadays and is the most common type of homeowners insurance. Like HO-2 coverage, special form policies cover physical structures both attached to and detached from your home at their replacement value, as well as your personal property at cash value, medical and liability coverage, and ALE.

However, unlike HO-1 and HO-2, your coverage isn’t limited by a list of named perils. Instead, you’re covered for everything except specific excluded perils that are listed in your policy. This is also known as “all-risks” coverage.

While you’re covered from all 16 of the perils already mentioned, in an HO-3 policy, the following perils are likely excluded:

• Damage or loss due to ordinance of law, acts of war, or government action.
• Damage or loss due to the movement of the earth (i.e., earthquake damage).
• Water damage due to flooding, including sewer backups.
• Mold, fungus, or wet rot (except due to accidental discharges or overflows as in the named perils).
• Damage or loss due to neglect (including vandalism if the home has been vacant for more than 60 days) or intentional loss or damage.
• Nuclear hazards.
• Theft during the construction of a dwelling.
• Wear and tear.
• Mechanical breakdowns.
• Smog, rust, and other corrosion.
• Smoke damage due to agricultural or industrial operations.
• Discharge or seepage of pollutants.
• Damage due to settling, bulging, shrinking, or expanding of parts of the structure (namely, the foundation).
• Damage due to vermin, birds, rodents, insects, or pets.

HO-5: Comprehensive form homeowners insurance coverage

Skipping HO-4—which, again, is the same as renters insurance and does not cover the physical structure of a home—we arrive at HO-5.

Comprehensive form homeowners insurance is the highest level of coverage available for most single-family homes. These plans are pricier and are usually only purchased if your property or belongings are particularly valuable. (Many insurance providers, including Allstate, Kin, Liberty Mutual, and Farmers don’t even offer this type of plan, defaulting instead to the more common HO-3 option.)

Here are the main differences between HO-5 and HO-3 plans:

• HO-5 plans cover your dwelling and personal property at their replacement value by default. With an HO-3 plan, you may need to get an additional rider for belongings to be covered above cash value.
• HO-5 offers all-risk coverage for both dwelling and personal property, while HO-3 plans offer all-risk coverage for your dwelling but named-peril coverage for your personal property.
• HO-5 policies may include higher coverage amounts for valuable belongings like jewelry, furs, and electronics, while HO-3 policies limit coverage for these items.

What does homeowners insurance cover?

As you can see, what’s covered depends on the type of policy you get. For most homeowners, HO-3 coverage is the best choice. These plans cover:

• The physical structure of your home, including detached physical structures like sheds or garages, at replacement cost.
• The cash value of your personal belongings (unless additional coverage is purchased).
• Liability coverage and medical payments to others in the event that someone is accidentally injured or sustains a loss at your family’s hands—which includes pets, but not intentional actions.
• Additional living expenses if you need to temporarily move while your home is repaired.

Of course, the only way to know for sure exactly what is covered by your policy is to read it—which we recommend you do, in full, prior to purchasing.

Different coverage options for homeowners insurance

You have some level of control when it comes to how much homeowners insurance coverage to buy—though, again, your mortgage lender may have certain minimum requirements. Chances are you won’t be able to get away with an HO-1 policy, for example.

Here are some of the choices you’ll need to make when determining your homeowner insurance coverage.

Type of policy

While HO-3 policies are standard and the most common, they’re not the only option on the market. Sometimes, another type of policy may make more sense for you.

Size of deductible

Like any other type of insurance policy, you can choose your deductible amount. Generally, the lower the deductible, the higher your monthly premium. However, you'll be on the hook for less money if a loss or damage occurs.

Amount of coverage

While higher coverage amounts come with higher premiums, you’ll have more peace of mind in the event of a catastrophic loss. You may also be able to purchase additional coverage for valuable belongings or upgrade to replacement-cost coverage of personal property rather than cash-value coverage.

Remember that, in the event of a loss, an appraiser or insurance adjuster will likely decide the replacement cost of various home structures.

You may also be able to customize how much liability and medical payment coverage your policy carries.

What does homeowners insurance not cover?

Most standard homeowners insurance policies list common perils that are not covered. However, you may be able to purchase additional coverage for added peace of mind.

Examples include:

• Earthquake damage.
• Flood damage.
• Pest or insect damage including termites and bed bugs.
• Maintenance costs.
• Many types of foundational damage.
• Most cases of mold.

How much does homeowners insurance cost?

According to Policygenius, the average cost of an HO-3 homeowners insurance plan is about $1,754 per year. This is for a plan offering $300,000 of dwelling coverage and $300,000 of liability coverage with a $1,000 deductible to a 40-year-old homeowner.

Factors influencing homeowners insurance rates

Your specific costs will vary based on where your home is located, how old it is, its level of repair, and many other factors—even the age of you, the homeowner.

Other factors that will play into the calculation include:

• Your credit score.
• Presence and breed of pets.
• Your marital status.
• Home safety features like smoke detectors.
• Home remodeling or renovations.
• Whether you own or finance your home.
• The current cost of materials.

Insurance companies factor in all of these considerations (and more) when they assess the risk level of a potential client, so averages can only get you so far when it comes to predicting what you might pay for homeowners insurance.

Calculating the adequate amount of homeowners insurance

There is a simple rule of thumb that can help you calculate how much homeowners insurance is adequate. Simply multiply the square footage of your home by the average per-square-foot building cost in your area. The latter number can change drastically depending on where you are and what the local labor costs, along with the dynamic price of materials.

If you’re not sure where to find the local building costs, contact your real estate agent, builders association, or insurance agent. They can also help you determine how much personal property and liability coverage is right for you and your family.

Tips for reducing homeowners insurance costs

Trying to keep your homeowners insurance costs low? Here are some ways to lower your monthly premium.

Consider a higher deductible

If you’d rather pay more out of pocket in an unlikely emergency in order to lower your monthly premium, consider opting for a higher deductible. Remember that while this will lower your premium payments, it won’t be worth it if you can’t afford the deductible when the time comes.

Consider purchasing less coverage

Again, the less coverage you buy, the less expensive your policy will be. You’ll also have less coverage, which may come back to bite you in the event of an emergency. That said, striking a balance can make your policy more affordable.

Upgrade your home

Home upgrades can drive down the cost of your insurance policy if they make your home sounder and safer. The only caveat is that if the value of your home increases substantially, your costs might increase some, too.

Shop around for the right provider

Even $10 a month can add up over the course of a 30-year mortgage, so it’s worth shopping around for the best possible insurance provider from the start. Most insurers will offer quotes if you answer just a few questions. The time you spend today could add up to big financial savings in the long run.

TIME Stamp: Homeowners insurance doesn’t have to be a hassle

While it can seem overwhelming at first, homeowners insurance is actually a fairly simple product. Like most types of insurance, you buy it because you want it to be there when you need it. Hopefully, you won’t need it very often, if ever.

Frequently asked questions (FAQs)

How do I file a homeowners insurance claim?

The claims process varies by insurer, but most companies make it easy to file a claim online. You’ll sign into your account and fill out the required information. You’ll likely need to upload photo or video evidence of damages and losses. Your insurance company will contact you to tell you what steps to take next.

What's the importance of creating a home inventory for insurance purposes?

Although documenting every single item you own might sound like a big pain (and be one), doing so can help you more accurately determine how much your personal property is actually worth. This can help you attain the right level of personal property coverage from your insurer.

The insurance company may also ask you to create an inventory in the event of a major loss, like a fire, so they can determine the cash or replacement value of those items. Chances are you’ll have enough on your plate when an emergency happens, so it may be worthwhile to make the effort sooner rather than later.

What is the 80% rule when it comes to insuring a home?

The 80% rule states that you must insure your home for at least 80% of its total replacement cost, lest you be penalized for being underinsured. For instance, if your home is worth $300,000, you should have at least $240,000 worth of insurance coverage for the dwelling structure. Keep in mind that these figures can change as you make improvements and renovations to your home.

What are the 3 basic levels of coverage that exist for homeowners insurance?

Homeowners insurance can cover the physical structure of your dwelling and your personal belongings at three levels:

1. Actual cash value: The insurer determines the loss’s current market value and pays that amount.
2. Replacement cost: Covers the cost of replacing the lost structure or item, which may be higher than its cash value.

Guaranteed/extended replacement cost: This is the highest level of protection, covering additional labor or material costs even if they exceed your policy’s stated limits. As the name suggests, this level of coverage may either extend the limits, usually by 10% to 25%, or guarantee that your covered structures will be replaced to their state before the loss regardless of price.