How to Shop for Homeowner’s Insurance

There’s just no getting around it: Anyone with a mortgage is required to have homeowner’s insurance.

You can’t obtain financing without it. And if you drop coverage any time after your loan closes, your lender has the right to place a policy on your place for you. It’s called “lender-placed” insurance in some quarters, or “force-placed” coverage in others. But by whatever name, there’s no getting around it. And it’s all spelled out somewhere deep in your loan documents.

Though you must have and maintain coverage to protect the lender’s collateral, you certainly don’t have to insure the land on which the house sits. After all, ground doesn’t burn, nor can it be stolen. Consequently, if the lender requires coverage in the full loan amount of your loan going in, there’s nothing to stop you from cutting coverage back to just the value of the house after settlement.

Of course, that demands that you try to determine your lot’s cost and separate it out from total cost of the property. But beware of cutting back too far. If you do, you might now have enough insurance to cover a future loss, as we’ll explain in a minute.

Types of Insurance Policies

First, there are several kinds of policies, depending on the house you are insuring. Older homes are usually covered under a policy that reimburses for damage on an actual cash basis, for example, while condominium apartment homes are covered under a policy that covers belongings and the structural parts of the building you actually own.

For most people, though, the choice boils down to either a basic policy known as HO2, which protects against 16 perils, and HO3, which protects your home from all perils, except those specifically excluded. The latter is the most popular because it is the most extensive.

HO3 covers damages caused by fire or lightening, loss of property that must be removed from the premises because it is endangered by fire or other perils, windstorm or hail, riot or civil commotion, aircraft, vehicles, smoke, theft, vandalism and malicious mischief. Also covered is damage resulting from falling objects, weight of ice or snow, the building’s collapse. sudden and accidental damage from a leaking water heater, accidental discharge from a plumbing, heating or air conditioning system or appliance and freezing plumbing.

Actual Cash Value, Replacement Cost and Guaranteed Replacement Cost

When purchasing a policy, you’ll have three other options — actual cash value, replacement cost and guaranteed replacement cost.

Actual Cash Value

A cash value policy pays to replace your home or possessions, less a deduction for depreciation, while a cash replacement policy pays the cost of rebuilding or repairing your home and replacing what’s lost without taking depreciation — the lost value over time — into account.

Replacement Cost

With a replacement policy, most insurers require coverage of at least 80 percent of the replacement cost, while some demand 100 percent. But because house prices usually rise — and sometimes rather rapidly — the amount you sign up for today may not be enough to maintain the required coverage percentage sometime in the future.

If you don’t carry the required 80 or 100 percent coverage and you have a partial loss, your carrier will pay only for a portion of the loss, even if the dollar amount on the policy is greater than the loss.

This is a little tricky and hard for many people to comprehend, so here’s an example: Say it would cost $300,000 to replace your house and you have the required 80 percent coverage, or a policy for $240,000. If you have a fire that causes $150,000 worth of damage, your partial loss will be covered completely.

Now suppose the place was insured for only $200,000. In this case, the insurer would pay for just two-thirds of your loss because you only carried 67 percent coverage. So you’d get a check for $100,000 and you’d have to cover the other $50,000 of your loss out of your own pocket.

You can get around this with an inflation-guard rider that adjusts your policy limits automatically. Not all carriers offer this type of rider, but even if they do, you should check periodically to make sure you have adequate coverage, but are not over-insured.

Guaranteed Replacement Cost

A third choice, a guaranteed replacement policy, provides an even higher level of protection. It pays the cost to rebuild your house as it was, even if the cost exceeds your policy’s limit.

Obviously, guaranteed policies are more expensive. Moreover, they may not be available where you live, on older homes or from certain companies. But if you can find such coverage, you’ll be protected, even if a widespread disaster causes a sudden spike in construction costs. As a less costly alternative, consider an extended replacement cost policy, which pays up to a certain percentage over the limit — typically 20 percent to 25 percent — to rebuild your house.

Other Considerations for Homeowner’s Insurance

At the same time, it’s a good idea to realize that no insurance policy will cover the cost to upgrade your house, even to current building codes. For that, you’ll need another rider that pays the extra cost to bring your property up-to-date.

Another thing to consider: So-called “out” structures not attached to your house — garages, for example, or storage sheds — need to be covered separately, typically for about 10 percent of the amount of coverage you have on your main dwelling.