You have just purchased your first home. Cash is tight, so you are weighing your options with homeowners insurance. How much coverage should you get? What type of policy is best for your needs? Do you really even need home insurance right now?
The truth is, homeowners insurance is a necessity. Not only because it protects your property and possessions against damage or theft. Mortgage companies require borrowers to have coverage for the full or fair value of a home (aka the purchase price). You won’t be able to get a loan or finance a residential real estate transaction without it.
There are different types of homeowners coverage and not all insurance is created equally. In other words, you generally get what you pay for. On top of that, there are also different policy tiers that offer various levels of protection depending on the needs of the homeowner and the type of residence. These tiers are designated as HO-1 through HO-8.
So, how do you determine which homeowners policy is right for you? Read on to learn more.
Understanding Home Insurance
There are three basic levels of coverage: Actual Cash Value, Replacement Cost, and Guaranteed (or Extended) Replacement Cost/Value.
Actual Cash Value
Covers the cost of your home plus the value of your belongings after deducting depreciation. Depreciation is the amount insured items are currently worth, not how much you actually paid for them.
Covers the actual cash value of your home and possessions without the deduction of depreciation. This type of coverage allows you to be able to repair or rebuild your home up to the original value.
Guaranteed (or Extended) Replacement Cost/Value
Considered an inflation-buffer policy, guaranteed replacement policies cover the inflated replacement costs and provide a cushion if construction prices increase. The policy pays for the actual cost to repair or rebuild your home. This applies even if the amount is more than your policy limit. Typically, the ceiling is 20% to 25% higher than the limit.
Policy Tiers: HO-1 through HO-8
Policy tiers offer various levels of protection depending on the needs of the homeowner and the type of residence.
This is the most basic form of home insurance you can buy. It is a bare bones policy that only covers your dwelling. In particular, HO-1 policies offer coverage for 10 specific perils, including:
- Fire and lightning
- Windstorm and hail
- Riots and civil commotion
- Damage caused by aircraft
- Damage caused by vehicles
- Smoke damage
- Volcanic eruptions
If something happens to your structure like an earthquake, flood, or falling object, it probably won’t be covered. Liability, personal property, medical payments, or additional living expenses are also not covered.
Only a handful of insurance companies sell HO-1 policies, as they are not a good option for most homeowners. Most mortgage lenders will not approve a loan with an HO-1 policy. Having this type of policy means the homeowner assumes a significant amount of risk which puts the mortgage company in jeopardy.
An HO-2 policy is another basic home insurance policy. It is commonly referred to as a “peril” policy. There are 16 named perils covered by this policy tier. The ten perils covered in HO-1, plus the following:
- Damage from the weight of snow, ice, or sleet
- Water damage from plumbing, heating, or air conditioning overflow
- Damage from water heater cracking, tearing, or burning
- Damage from electrical currents
- Damage from frozen pipes
- Damage from falling objects
Unlike HO-1 policies, they do offer coverage for liability, personal property, additional living expenses, and medical payment to others.
Like HO-1 policies, they are uncommon and are generally only written by insurance companies if they deem the risk presented is too great for a higher-level policy.
The most common tier of homeowners insurance, an HO-3 policy covers property damage, legal liabilities, and other expenses associated with unexpected disasters damaging your home. It is considered an “open-perils” policy because it covers homes against all dangers unless they are specifically listed as exclusions.
The foundation of an HO-3 policy is coverage of property damage. However, it also serves as protection against legal liability, and the costs of living outside of your home after an emergency.
Coverage and typical limits for an HO-3 Policy include:
- Dwelling: limited to cost to rebuild home
- Other structures such as fences and freestanding garages: limited to 10% of dwelling limit
- Personal property: limited to 50% of dwelling limit
- Loss of use: limited to 10% of dwelling limit
- Personal liability: your choice
- Medical payments: your choice
Perils typically excluded on an HO-3 policy include:
- Government seizure, demolition, or requirement to rebuild to match building codes
- Earthquakes, sinkholes, and landslides
- Off-residence power failure
- Homeowner neglect
- War and nuclear hazards
The HO-4 Policy is commonly known as Renter’s Insurance. HO-4 policies cover the same perils as most homeowners policies. They also include additional living expenses, personal liability, and personal property. They don’t include dwelling and other structures. Insurance companies allow renters to increase insurance limits and also offer optional coverage for valuable items.
HO-5 policies are commonly referred to as “comprehensive form.” They provide the most complete homeowners coverage and are designed for high-value homes. HO-5 policies include the same coverages as HO-3, but unlike HO-3 policies, HO-5 also includes the added benefit of extending the open-peril feature to your personal belongings.
Those with high-value homes often need coverage for identity theft protection and scheduled property insurance to cover expensive items such as artwork. Selecting $1 million or more in personal liability limits and personal property coverage will also protect items such as laptops and jewelry when taken on vacation with you.
There are certain types of personal property that aren’t usually covered on an HO-5 policy, including:
- Fraudulent charges to credit or debit cards
- Land, including the lot your home is on
- Plants, shrubs, and trees
- Property covered by a separate policy
- Property of lodgers
Typical perils which are excluded in most HO-5 policies include:
- Rodent infestations
Many insurers do offer separate earthquake and flood insurance as supplemental policies.
HO-6 policies are for those who own a condominium or co-op unit. Although you are likely responsible for damages to your unit, the condo or co-op association will typically have primary responsibility of insuring all common areas.
Like homeowners insurance, HO-6 policies provide coverage against standard perils such as fire or smoke damage, storms, vandalism, and internal plumbing issues such as a burst pipe. Personal property coverage includes items such as furniture, clothing, electronics, and jewelry in your condo, and personal liability covers applicable legal and medical expenses. If your unit becomes uninhabitable by a covered cause of loss, help with additional living expenses will be covered. Finally, loan assessment coverage will help cover you when you are responsible for additional costs shared by the condo association that are not covered by their insurance policy.
HO-7 policies provide HO-3 level coverage for mobile homes. Open-perils coverage is provided at replacement cost for dwellings. Both the home and detached structures like fences or a garage are covered. Content is covered against named perils.
An HO-8 policy is sometimes referred to as the modified coverage form. Considered a “named-perils” policy, HO-8 covers losses caused by the same 10 specific perils included in HO-1 policies. This is a special type of home insurance designed for homes that are 40 years of age or older, or are listed as an historic home on the National Register of Historic Places.
Because of original electrical wiring, heating and air conditioning systems, and plumbing many older homes do not qualify for HO-3, making HO-8 the best option. Outdated systems pose a higher risk to insurers because of specialized craftsmen, unconventional building methods, and difficult to source materials are required to bring homes up to code.
Unlike conventional homeowners policies, which provide enough coverage to completely rebuild your home, most HO-8 policies only pay the actual value of your home. This is often much less than the cost to rebuild.
Save and Compare
It’s time to protect your home with adequate homeowners insurance. Not sure which plan is right for you? The Rue Crew is here to customize a plan designed especially for your unique needs to ensure you get the best homeowners policy available.