What is homeowners insurance and how does it work?

Owning a home is expensive enough when things are going well, but repair bills after significant damage can easily cost thousands of dollars. Expenses like these can be difficult to cover out of pocket, which is where home insurance comes in.

Homeowners insurance acts as a financial safety net. It helps pay to repair or replace your house or belongings if they are damaged by covered events like fire, theft, vandalism, or severe weather. It also helps protect you financially if someone gets hurt on your property or if you accidentally damage someone else’s property and are held legally responsible.

How does homeowners insurance work?

When you buy home insurance, you’re entering into a contract with your insurance provider. The insurer agrees to help cover property loss or damage caused by certain hazards, called perils, in exchange for a fee. 

Here are a few home insurance basics you should know.

• Premium: This is the cost of your policy, which usually covers a one-year term. You can typically pay for it all at once or in monthly installments. If you have a mortgage, your lender will likely pay the bill for you through an escrow account. You fund this account through a portion of your monthly mortgage payment, and the lender handles the actual disbursement to the insurance company.
• Deductible: This is the amount of damage you agree to cover out of pocket when you file a claim. For example, if your deductible is $1,000 and your covered damage is $5,000, you pay $1,000, and the insurer covers the remaining $4,000.
• Policy limits: Your insurance policy has caps on how much it will pay for various losses. You typically have the option to raise your limits for extra protection, but your policy will cost more.
• Claims: In the event of covered damage, like a fire that destroys your kitchen, you’ll file a claim with your insurance company. They’ll inspect the damage, determine what’s covered, subtract your deductible, and then pay for repairs or replacements up to your policy limit. 

What does homeowners insurance cover?

Standard home insurance is called an HO-3 policy and includes the following coverage:

• Dwelling coverage (Coverage A): Applies to the structure of your home, including the walls, floors, built-in appliances, the roof, and attached structures like a porch or deck.
• Other structures coverage (Coverage B): Covers detached structures on your property, such as a fence, shed, or detached garage.
• Personal property coverage (Coverage C): Protects your belongings, like clothing, appliances, electronics, and furniture, if they’re damaged, destroyed, or stolen.
• Additional living expenses coverage (Coverage D): Also called loss of use coverage, ALE helps cover expenses such as hotel bills, meals, and other costs if you need to live elsewhere temporarily while your house is being rebuilt or repaired.
• Personal liability coverage (Coverage E): Covers legal defense and settlement costs if someone is injured on your property or you or a household member damages someone else’s property and you’re found legally liable.
• Medical payments coverage (Coverage F): Helps cover small medical bills if a guest is injured on your property, even if you’re not at fault.

Common homeowners insurance exclusions

No insurance policy covers everything. Here are common things a standard homeowners insurance policy doesn’t cover:

• Earthquakes, landslides, and mudslides
• Flood damage
• Regular wear and tear or maintenance issues
• Pest and insect damage
• Sinkholes
• Nuclear accidents and war
• Sewer backups

You can buy optional add-on coverage, called endorsements, or separate policies to cover some of these exclusions. For example, if you’re worried about sump pump failure or drain backups, you can add a water backup endorsement to your policy. 

Many insurers also offer an earthquake endorsement if you live in an area where seismic activity is a concern. And if you live in an area prone to flooding, you can purchase an endorsement or separate flood insurance policy.

Types of homeowners insurance policies

There are multiple types of homeowners insurance policies available, with different levels of coverage. Basic form policies only cover 10 named perils, while a broad form covers 16, including things like falling objects, ice or snow damage, and water damage from plumbing issues. Special form policies are the most common for homeowners because they offer the broadest protection, covering all perils except those specifically excluded.

How much does homeowners insurance cost?

How much you’ll pay for homeowners insurance varies widely. Policy premiums are based on factors like:

• Where you live
• Your home’s age, size, and condition
• The coverage and policy limits you choose
• The deductibles you select
• Your claims history
• Local risk factors like crime and weather

According to the Consumer Federation of America, the national average premium for a home with $350,000 in dwelling coverage is $3,303 per year, or around $275 per month. 

Frequently asked questions

Is homeowners insurance required by law? 

No. Legally speaking, home insurance is not mandatory. But if you have a mortgage, the lender almost always requires it to protect its financial interest in the property until you pay off your loan balance. Even if you own your home outright, financial experts recommend that you continue to carry coverage.

How much does homeowners insurance cost? 

The average annual cost of home insurance in the U.S. is $3,303 per year for $350,000 in dwelling coverage. That said, your actual rate may be higher or lower depending on things like your home’s age, square footage, and location; the coverage types, policy limits, and deductibles you choose; past claims you’ve filed; your credit score (in states that allow it); and other factors.

What is the difference between replacement cost and actual cash value?

Replacement cost value (RCV) coverage pays to repair or rebuild your home or replace belongings at today’s prices, even if they cost more than what you originally paid or are currently worth. Actual cash value (ACV) coverage factors in depreciation, meaning older items might only be reimbursed for what they’re currently worth, not what they’d cost to buy today.

Does homeowners insurance cover dog bites? 

Most standard homeowners insurance policies include liability coverage that helps pay for medical bills and legal fees if your dog bites someone. However, some insurers restrict certain breeds, or they may exclude animal liability entirely if your pet has a history of aggression. If that’s the case, you might need a specific animal liability endorsement or a separate policy to ensure you're protected.