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What is homeowners insurance?

Understanding how home insurance policies work

Profile picture of Kathryn Parkman
by Kathryn Parkman ConsumerAffairs Research Team
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Homeowners insurance is a policy that protects you from financial loss if accidents or disasters occur on your property. Your insurance agent will offer different types of insurance based on the type of house you buy and the coverage you need. Homeowners policies are written as standardized forms, HO-1 through HO-8, making it easier for states to regulate the insurance industry.

How does homeowners insurance work?

You need home insurance for two primary reasons: protecting your assets and satisfying your mortgage lender. Standard coverage includes damage to the home, other structures and personal belongings. It also covers financial liability due to injury or property damage caused by residents of the home. Homeowners need enough coverage to pay for the costs of completely rebuilding after a major disaster.

For example, practically all home insurance policies cover fire and smoke damage. If there’s a fire, the homeowner files a claim, then the insurance company investigates and offers compensation within the policy’s limits.

During the claims process, the insurer’s adjuster assesses damages caused by the incident and provides a preliminary estimate of the total cost for cleanup, repairs and restoration. Most homeowners insurance adjusters work for private insurance companies, but you can also hire an adjuster who works independently to conduct non-sanctioned appraisals.

Policies can have exclusions, and you might be required to buy an additional endorsement to cover damage from floods or earthquakes or to insure high-value possessions.

Just like other types of insurance, a homeowners policy requires you to pay yearly premiums. Most lenders hold money in your escrow account to cover the cost of the policy, bundling it with monthly mortgage payments. Nearly all policies also require a deductible, which is how much you have to pay for a service before your insurance company covers the rest.

Types of homeowners insurance policies

The most common type of homeowners insurance policy for single-family homes is an HO-3 policy, which offers broader coverage than HO-1 and HO-2 policies. Home insurance policy forms exist for different types of houses. For example, HO-6 is specifically for condos and HO-7 is designed for mobile homes.

HO-1: Basic Form

HO-1 forms are rarely used in 2020. The most basic form of homeowners insurance provides coverage against 10 named perils for direct damages to property, personal liability and medical payments. Basic Policy Form 1, drafted initially as part of the original Insurance Services Office Inc. homeowners form portfolio, has been discontinued in most states.

HO-2: Broad Form

HO-2, or broad form, policies provide coverage for the 10 named perils included in a basic form, plus six more:

  • Fire or lightning
  • Smoke
  • Hail or windstorms
  • Explosions
  • Riots or civil commotion
  • Damage caused by aircrafts
  • Damage caused by vehicles
  • Vandalism or malicious mischief
  • Theft
  • Volcanic eruptions
  • Falling objects
  • Weight of ice, snow or sleet
  • Accidental discharge of water or steam
  • Sudden and accidental damage to some household systems
  • Freezing of household systems
  • Sudden and accidental damage to electrical currents

Broad form policies typically include coverage for personal property and liability. However, the coverage only applies to damages caused by one of the 16 named perils and personal liability coverage. HO-2 policies specifically exclude coverage for floods and earthquakes.

HO-3: Special Form

This is the most common type of home insurance policy because it provides coverage for several different areas:

  • Your house or dwelling
  • Other structures on the property
  • Personal belongings or assets
  • Additional living expenses
  • Personal liability
  • Medical fees

With an HO-3 form, personal property is covered by named perils, and your house is covered under open perils. Open peril policies provide coverage for damage caused by any reason not excluded in the policy. A closed peril policy only offers reimbursement for the destruction caused by a specific peril named in the policy, such as a fire or vandalism.

HO-3 forms cover most natural disasters. They specifically spell out what’s excluded, and they include dwelling coverage, liability and other structures coverage.

HO-4: Contents Broad Form

Also called renters insurance, contents broad form policies are specifically designed to protect renters’ personal property and assets. An HO-4 works similarly to an HO-2 and covers the same 16 perils. The main difference is that renters insurance only covers personal belongings because the property owner is the one who insures the dwelling. Most HO-4 policies also include liability coverage.

HO-5: Comprehensive Form

This is an open peril policy and can cover damages from earth movements, floods, water damage, pets, mold, war and deterioration. Not every home is eligible for HO-5 insurance, and not every insurance provider offers it. Usually homeowners upgrade to an HO-5 from an HO-3 if they have valuable belongings they specifically want covered.

HO-6: Unit-owner’s Form

Otherwise known as condo insurance, this type of policy covers personal property and the structure of the condo. Condo insurance usually offers coverage for the same 16 perils as with HO-2 policies. If you buy a condo, you'll likely be required to carry an individual condo insurance policy, even if your condo association has its own coverage.

HO-7: Mobile Home Form

This insurance is also like an HO-2, but it’s for owners of manufactured or mobile homes, including single- and double-wide trailers, RVs and modular homes. HO-7 policies offer the same broad form coverage for named perils. These are solely for protecting the home while it's stationary. You'll need an additional policy to cover a mobile home in transit.

HO-8: Modified Coverage Form

An HO-8 policy works on the named peril basis, similar to an HO-1. Modified coverage forms are most often used for older or historic homes. With this type of policy form, coverage is available even if the cost of repairs or replacements outweighs the home’s actual cash value.

Understanding home insurance FAQ

How is home insurance calculated?
Homeowners insurance is calculated based on various factors, including the value of the home, its location, personal details of the owners and the policy deductible. The premium rate may change each year when the policy is renewed. Many discounts are available, so ask your insurance provider which savings you qualify for. Keep in mind that reducing coverage to save on premium costs can leave you exposed to financial risk in the worst-case scenario.
How do you get homeowners insurance?
Acquiring a homeowners insurance policy is very straightforward. Many home insurance companies accept online applications, while others offer a local agent network or phone policies. During the signup process, an agent will help calculate how much coverage you need and customize your policy to your home and belongings. The insurance company arranges payment with the mortgage company or homeowner, with the cost of the premium typically deducted from an escrow account. The policy then renews each year, potentially with a higher or lower premium.
What is the difference between mortgage insurance and homeowners insurance?
Mortgage insurance protects a mortgage lender if the borrower defaults on payments. Homeowners insurance covers the cost to rebuild or repair after a major disaster.

Both are typically required if you borrow money to buy a house. However, you can get out of paying for PMI if you make a larger down payment. Borrowers who provide less than 20% of the purchase price as a down payment will need to pay mortgage insurance, a cost that’s wrapped into their monthly mortgage payment.

Homeowners insurance protects the homeowner from financial responsibility if the home or property is damaged, if anyone is injured on the lot and for a range of other circumstances. This cost may also be included in the monthly mortgage payment, with the premium paid annually from the escrow balance.

Why do you need home insurance?
The vast majority of lenders require that you have this coverage in place before they'll lend you money for a mortgage. Practically all lenders require that you have home insurance that covers the full or fair value for your house before they'll give you a mortgage. It's basically essential if you mortgage a house.

Even if you happen to find a lender that doesn’t require it, homeowners insurance might still be a smart idea. This insurance doesn’t just protect your home and belongings — it also helps you secure a mortgage in the first place. Most lenders require that you have a homeowners insurance policy throughout the lifetime of your loan. Even so, homeowners still have the flexibility to customize their loan to fit their needs and their budget.

Bottom line

Suppose you were to experience the total loss of your home. In this case, a home insurance policy would pay to rebuild or repair it. Homeowners insurance isn’t just important for your peace of mind; it’s also required by mortgage lenders. Finding the best home insurance plan depends on what type of dwelling you live in and what perils you most want covered. We recommend comparing a few companies before making your final decision.

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Profile picture of Kathryn Parkman
by Kathryn Parkman ConsumerAffairs Research Team

As a member of the ConsumerAffairs Research Team, Kathryn Parkman believes everyone deserves easy access to accurate and comprehensive information on products and businesses before they make a purchase, which is why she spends hours researching companies and industries for ConsumerAffairs. She believes conscious consumption is everyone's responsibility and that all content deserves integrity.