How Does Homeowners Insurance Work?

If you own a home, you know how important it is to protect your investment. Many things that are completely out of your control could happen to your property. Fire, theft, tornados, or a slip and fall on your property are just a few examples. 

Homeowners insurance is designed to financially protect you from these events and more, so you’re not left footing the bill. But before you choose a policy, it’s essential to understand how life insurance works. 

In this guide:

• Typical homeowners insurance types and coverage
• How homeowners insurance works
• How does homeowners insurance work for different types of properties?
• How to purchase a homeowners insurance policy

Typical homeowners insurance types and coverage

As you shop for the best home insurance, you’ll come across eight policy types geared to homeowners’ specific needs. 

The primary difference between policies is which “perils” each covers. A “peril” is a term insurance companies use to describe the type of event that could cause damage or loss (for example, fire or theft).

Some policies, such as HO-1 and HO-2, are named peril policies, meaning the policy only covers events listed in the policy. Commonly covered perils include fire, windstorms, theft, and explosions.

HO-3 is the most popular type of insurance because it provides the broadest coverage. Rather than stating which perils it covers, it’s an open peril policy, so it protects against everything except listed exclusions. Exclusions may include floods, earthquakes, and termites.

How homeowners insurance works

Understanding how homeowners insurance works is essential for knowing what you’re covered for and the steps to take if you need to file a claim. The homeowners insurance process generally involves these four steps:  

• Pay a premium
• File a claim
• Pay a deductible
• Replace or fix your property

Pay a premium

Premiums are the payments you make to keep your homeowners insurance policy in effect. Most homeowners pay their premiums monthly or quarterly, and the amount varies depending on your home’s location, age, and size. Your credit score can also impact the rate you pay.  

You generally have two options for paying premiums:

1. Escrow—Your mortgage lender can make payments on your behalf through your escrow account. This is a special account your lender sets up to hold your mortgage payment and homeowners insurance payments. 

2. Direct—You can pay premiums directly to your insurance company. 

Example

Joe is a homeowner with an HO-3 policy, and his insurance premium is $300 per month. However, Joe doesn’t pay it himself. Rather, it’s rolled into his mortgage payment, so Joe’s mortgage lender pays his premium through escrow.

File a claim 

If your home or personal belongings are damaged or lost due to a covered event, you can file a claim with your homeowners insurance company. Covered events can include things like fire, theft, or natural disasters. 

To file a claim, you’ll need to contact your insurance company and provide them with information about the damage or loss. They may send an adjuster to assess the damage and determine the claim amount.

Example

A bad storm comes through and damages Joe’s roof. He logs into his homeowners insurance account and files a claim online with his insurance company. The company asks Joe to submit photos of the damage and has an assessor come out to estimate how much repairs will cost.

Pay a deductible 

You’ll likely need to pay a homeowners insurance deductible when you file a claim. This is the amount you’re responsible for paying before your insurance company steps in and covers the rest of the claim. 

Generally, a higher deductible equals a lower premium, and vice versa. No matter the deductible you choose, keep at least that much money in an emergency fund so you’re prepared if you need to file a claim. 

Example

After the assessor leaves, Joe’s insurance claim for roof damage is $7,000. Joe would be responsible for paying $500 of the claim amount, and his insurance company would pay the remaining $6,500. 

Replace or fix your property

Once your claim is approved, you’ll receive a payout from your insurance company. You can use this money to replace or fix your damaged property. However, the total payout you receive will depend on your coverage type. 

• Replacement cost coverage provides the amount needed to replace your property with new items of similar quality. If the repairs cost more than the initial insurance payment, you may have to cover the expenses out of pocket and submit paid invoices to your insurance company for reimbursement.
• Actual cash value coverage considers depreciation and may result in a lower payout. 
• Extended replacement cost coverage gives you additional coverage beyond the policy limit. 

Before taking out a home insurance policy, read up on the differences between actual cash value vs. replacement cost and how it affects your payout for a claim. That way, you can choose a policy with the coverage you need.

Example

Joe’s damaged roof is estimated to cost $7,000 to replace. Because he has replacement cost coverage and a $500 deductible, he would receive a check for $6,500 to cover the repair.

How does homeowners insurance work for different types of properties?

Homeowners insurance policies vary depending on the type of property you own. Here are a few things to keep in mind:

Condominiums

Condo owners typically need an HO-6 policy instead of a traditional homeowners policy. This is because your condo association likely has a master policy that covers the building’s structure and common areas. 

Your HO-6 policy covers your personal belongings, any upgrades you’ve made to the unit, and any liability issues that may arise.

Rental properties

If you own a rental property, you’ll need a specialized landlord insurance policy. This type of policy typically covers the structure of the building, your liability as a landlord, and lost rental income if the property becomes uninhabitable due to a covered event.

Mobile homes

Mobile homes require an HO-7 policy covering the structure and your personal belongings. These policies may also include coverage for liability issues on your property.

How to purchase a homeowners insurance policy

You can purchase homeowners insurance online or through an agent using these steps:

1. Determine your coverage needs—Consider factors such as the value of your home, your personal belongings, and any add-ons you might need, like flood insurance.
2. Shop around for quotes—Contact multiple insurance companies to compare coverage options and prices.
3. Review policy details—Ensure you understand what your insurance policy covers and what’s not, along with any deductibles or limits.
4. Purchase your policy—Once you’ve chosen the best policy for your needs, sign the paperwork and make your first payment.

Although homeowners insurance isn’t required by law, it’s typically required by mortgage lenders. Even if you own your home outright, having a comprehensive policy is still wise. Use an online home insurance calculator to estimate how much coverage you need.