Your lender will require homeowners insurance before closing, but most buyers never read their policy closely enough to understand what is actually protected -- and what is not.
HO-3 vs. HO-5: The Two Policies You Need to Know
The HO-3 is the most common homeowners insurance policy in the United States. It covers your dwelling (the structure itself) on an "open perils" basis, meaning it covers everything except what is specifically excluded. However, it covers your personal property (furniture, electronics, clothing) on a "named perils" basis, meaning it only covers losses from a specific list of causes like fire, theft, vandalism, and certain weather events.
The HO-5 is a more comprehensive (and more expensive) policy that covers both your dwelling and personal property on an open perils basis. This means your belongings are protected against any cause of loss that is not explicitly excluded. If you own high-value personal property or simply want broader protection, an HO-5 may be worth the additional premium, which is typically 5-10% more than an HO-3.
What Homeowners Insurance Covers
A standard homeowners policy includes several types of coverage, each with its own limits:
- Dwelling coverage (Coverage A): Pays to repair or rebuild your home if it is damaged by a covered peril. This should be set at the full replacement cost of your home -- not the market value, which includes land.
- Other structures (Coverage B): Covers detached structures like garages, fences, and sheds. Typically set at 10% of your dwelling coverage.
- Personal property (Coverage C): Covers your belongings inside the home. Usually set at 50-70% of your dwelling coverage. High-value items like jewelry, art, and collectibles often have sub-limits and may need a separate rider or floater.
- Liability (Coverage E): Protects you if someone is injured on your property and sues. Standard policies start at $100,000, but most advisors recommend at least $300,000-$500,000. An umbrella policy can extend this further.
- Loss of use (Coverage D): Pays for temporary living expenses (hotel, meals, rental) if your home is uninhabitable due to a covered loss. This is often capped at 20% of dwelling coverage.
What Homeowners Insurance Does Not Cover
The exclusions are where most homeowners get caught off guard. Standard policies do not cover:
- Flooding: Damage from rising water, storm surge, or overflowing rivers is not covered. You need a separate flood insurance policy through the National Flood Insurance Program (NFIP) or a private insurer. Even if you are not in a high-risk flood zone, consider it -- about 25% of flood claims come from low-to-moderate risk areas.
- Earthquakes: Seismic damage requires a separate earthquake policy or endorsement. This is essential in California, the Pacific Northwest, and parts of the Midwest.
- Maintenance and wear: Gradual deterioration, mold from ongoing leaks, pest infestations, and general neglect are not covered. Insurance is for sudden and accidental events, not deferred maintenance.
- Sewer and drain backup: Water damage from backed-up sewers or drains is excluded unless you add a specific endorsement, which is relatively inexpensive and highly recommended.
Replacement Cost vs. Actual Cash Value
This distinction matters enormously when you file a claim. Replacement cost coverage pays to replace or repair your property with materials of similar kind and quality at current prices, with no deduction for depreciation. If your 10-year-old roof is destroyed, replacement cost pays for a brand new roof.
Actual cash value (ACV) pays the replacement cost minus depreciation. That same 10-year-old roof with a 20-year lifespan might only be valued at 50% of replacement cost under an ACV policy. You would receive significantly less and need to cover the gap out of pocket.
Always choose replacement cost coverage for both your dwelling and personal property if your budget allows. The premium difference is modest compared to the financial protection it provides. Also verify that your dwelling coverage amount keeps pace with construction costs -- rebuilding a home today costs more than it did even a few years ago due to material and labor inflation.
How to Save on Homeowners Insurance
There are several legitimate ways to reduce your premium without sacrificing important coverage. Bundling your homeowners and auto insurance with the same company typically saves 10-25%. Raising your deductible from $1,000 to $2,500 can lower your premium by 10-15%, though make sure you can afford the higher out-of-pocket cost if you file a claim.
Installing a security system, smoke detectors, and deadbolt locks can qualify you for discounts. Some insurers offer lower rates for newer homes, upgraded electrical and plumbing systems, or impact-resistant roofing. Ask your insurer for a full list of available discounts -- most homeowners qualify for at least one or two they are not currently receiving.
Shop around every 2-3 years. Loyalty rarely pays in insurance. Get quotes from at least three companies and compare coverage limits and deductibles, not just premium prices. The cheapest policy is not always the best value if it leaves gaps in your protection.