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What is home insurance?

Everyone who owns a home needs home insurance, which pays to repair structural damage, replace damaged or stolen property, and defend homeowners against liability lawsuits.

"A home insurance policy is the best buy a homeowner can make," says Pete Moraga, spokesman for the Insurance Information Network of California. "It protects their home from many perils. It can protect against fires, theft, vandalism and falling objects."

Debbie Quinlivan, a senior product consultant for MetLife, says she can envision no case in which home insurance isn't necessary.

This is because few people have enough savings to cover the costs of major damage to a dwelling and its contents, she adds.  Repairs for such losses as fires and storm damage easily can run into tens of thousands of dollars.

If a disaster completely wiped out your single-family home, the cost of reconstruction could exceed $200,000. According to a January 2014 report from the National Association of Home Builders trade group, the average cost of single-family home construction in the U.S. was $246,543 in 2013.

what is home insurance How much home insurance should you buy?

Your goal should be to buy only enough insurance to cover the cost of repairing or replacing your home and replacing its contents, regardless of the home's value on the real estate market, Moraga says.

For example, a home that might sell for $500,000 may cost only $100,000 to rebuild. This is because you are paying out for the structure only, and not the land that it’s built upon.  

To find out how much it would cost to rebuild your home, get estimates from local building contractors. Be sure to provide an accurate description of your home's square footage, the number rooms, and the types of materials that went into construction.   

What are the components of a home insurance policy?

There are many types of policies, but the most widely used is a standard plan, also known as an HO-3. Michael Barry, a spokesman for the nonprofit Insurance Information Institute (III), says this policy typically consists of four components.

1.  Coverage for the structure of your home. This typically includes the house plus unattached buildings on your property, such as a garage or a tool shed.

2. Coverage for your personal belongings. A standard policy includes off-premises coverage. That means your personal belongings typically are covered anywhere you go. For example, if you were on vacation and your belongings were stolen from your hotel room, your home insurance policy typically would cover your loss, up to the limits of your policy.

3. Coverage for personal liability. If members of your household are sued for causing property damage or injuries, this pays for their legal defense and covers financial penalties imposed by courts, up to your policy limits.

4. Additional living expenses (ALE). If you are forced to leave your home, this coverage pays for your out-of-pocket costs for food and lodging, up to your policy limits. For example, your policy may cover your living expenses for one year after you file your claim.

Similar policies are available to renters. Renters insurance covers personal belongings and provides liability protection.

What’s the difference between actual cash value and replacement value?

A policy typically includes a clause that explains how much coverage you have. The clause lists property that will be valued at actual cash value, and property that will be valued at the cost of replacement.

To calculate actual cash value, insurance companies depreciate items based on their age, Quinlivan says.  

For example, if someone steals your 10-year-old sofa, actual cash value coverage would pay only the amount you would expect to pay for a 10-year-old sofa. In contrast, replacement-cost coverage requires the insurer to pay to replace your old sofa with a new one of similar quality.

With replacement-cost insurance, the policyholder typically has no out-of-pocket costs, after paying their deductible.

Is home insurance legally required?

Quinlivan says there is no legal requirement to buy home insurance. However, if you use a loan to finance your home purchase, you’ll be required to buy home insurance to protect your lender's investment.

Once the loan is repaid, you’re free to drop your home insurance policy. However, this will leave you on the financial hook if your home or its contents are damaged. You also will lose the personal liability coverage that a home policy provides.

How much does homeowners insurance cost?

According to the National Association of Insurance Commissioners (NAIC), the average annual premium homeowners paid nationally in 2011 -- the most recent year for which NAIC figures are available -- was $978. The average cost for renters insurance was $187. 

Many tenants mistakenly believe they don't need renters insurance. They often think their landlord's insurance policy covers the contents of rental units, Quinlivan says. A 2013 poll commissioned by the III found that 96 percent of homeowners had insurance protection, but only 35 percent of renters had purchased coverage.

What is a home insurance deductible?

Your home insurance policy deductible is the money you have to pay out of pocket before your coverage kicks in. For example, if you have a $2,000 deductible and your home suffers $5,000 worth of storm damage, you’ll be on the hook for the first $2,000 and your insurer will cover the remaining $3,000.

Moraga says you may be able to cut your home insurance costs by raising your deductible. Typically, the higher your deductible, the lower your premium. However, a higher deductible means you will have to pay the full cost of small claims, such as broken windows, damaged fences or missing shingles from the roof.

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