How Does Homeowners Insurance Actually Protect You?

If you own a home, you need to have homeowners insurance. Chances are the bank will require you to have a policy if you have a mortgage -- but getting covered is essential, even if you own your home outright. Homeowners insurance policies provide protection from various calamities that could cause major financial loss, so it's worth your time to make sure you have the right policy in place.

To ensure you're fully protected by your homeowners insurance, you should also know a few key details about exactly how this coverage works. When you have a clear understanding of the protection your coverage should provide, you can review the terms of your policy and make adjustments, as needed, to reduce your risk of financial harm.

What does homeowners insurance actually cover?

A typical homeowners insurance policy will provide three specific types of coverage:

  • Liability protection: This is the coverage you'll rely on if someone falls down the stairs in your home or your dog bites someone. If you're sued because someone gets hurt, your liability insurance will pay legal fees and cover the costs of any settlement or judgement against you. A lawsuit could be very expensive to defend against, and losing one could leave you on the hook for hundreds of thousands of dollars in medical bills, lost wages, and other damages -- depending on the severity of the injury. Ensure you have sufficient liability coverage so your insurer, and not you, gets stuck with the bills.
  • Protection for your dwelling and other structures: You'll also need coverage to protect you in case something happens to your home or other structures on your property, such as a screened-in lanai, a freestanding garage, or a barn. Coverage for your dwelling could pay for repairs or rebuilding your home or other structures in the event that a problem is caused by a covered peril. If your barn burns down or your home is damaged when a pipe bursts, your policy should cover you.
  • Protection for personal property: You likely have most or all of your possessions in your home -- and probably can't afford to replace everything you own. Personal-property protection gives you the money you'll need to replace your stuff if it's damaged or destroyed by a covered peril or if it's stolen.

Make sure your policy has all of these different types of coverage -- unless, of course, you can afford to defend against very expensive lawsuits, rebuild your home, or replace your property from scratch if something happens.

How does coverage work?

It's helpful to know not only what your policy covers, but also how coverage will work if something actually goes wrong.

First and foremost, you'll get an insurance payout only for covered perils. If the loss is caused by something not covered by your homeowner's policy, you won't be able to make a claim. Many homeowners insurance policies exclude flood damage, for example -- so if your home floods, you won't receive any compensation from your homeowners insurer. If you live in a flood-prone area, you'll want to buy separate flood insurance coverage so you don't lose everything because of water issues.

You'll also be compensated only up to policy limits. If you have $25,000 in coverage for personal property, the most your insurance policy will pay out is $25,000 if every bit of your property is destroyed. Make sure you have sufficient coverage and that your policy limits aren't set too low; otherwise, you'll have large out-of-pocket losses. Look closely at your policy, too, as there are sometimes limits on coverage for specific items. For example, even if you have $25,000 in coverage for personal property, you may be limited to $2,500 in coverage specifically for jewelry -- unless you buy an additional rider to cover your expensive baubles.

Your coverage may also be limited if you have market value coverage instead of replacement value coverage. If you have market value coverage, you'll only be compensated for what your home or possessions are currently worth. If your house is worth $100,000 on the open market but would cost $300,000 to rebuild because it's got lots of custom details, you'd absolutely want to ensure you have replacement coverage, which compensates you for the amount it takes to restore you to the position you were in before the covered peril occurred.

Finally, you need to be aware you're responsible for covering the deductible before your insurance will pay for losses. If you have a $2,500 deductible, you'd have to pay for the first $2,500 in damage from a covered peril before your insurance would give you any cash.

Make sure your policy protects you

Now you understand the basics of how homeowners insurance works. Make sure to keep your policy limits high enough to cover you and know the difference between replacement and market value. Also, understand what perils and possessions are covered and that you can afford your deductible.

If you find your policy isn't providing the protection you need, talk with your insurance agent about getting more coverage. Premiums will be higher if you opt for higher policy limits, broader protection, or a lower deductible, but paying slightly more for coverage may be worth the peace of mind you'll achieve.

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