Buying a home usually takes several years of savings and hard work, but a fire or inclement weather can destroy it in a matter of minutes. Homeowner’s insurance is designed to protect your investment in a residence, and unless you purchase a home for cash, you will have a mortgage lender who will mandate at least hazard insurance coverage equal to their financial interest.

While your lender will mandate hazard insurance coverage to protect their interest, you should consider protecting your own equity. If you buy a home with a low down payment loan, your equity will be small. However, if your loan-to-value ratio (your mortgage balance divided by the home’s purchase price) is 80% or less, you should protect your 20% (or more) in equity.

I have sat down with my colleague Michael J. Crowley, V.P. of Crowley Insurance Agency, to answer your basic questions regarding homeowner’s insurance coverage.

Courtney:      Mike, I am asked frequently by clients what the difference is between hazard insurance (required by lenders) and homeowner’s insurance. What is the difference and why is homeowner’s insurance important?

Mike:              Yes, Courtney. What most people do not realize is that hazard insurance is not synonymous with homeowner’s insurance. Hazard insurance only covers physical damage, whereas homeowner’s insurance typically includes liability protection and hazard insurance. Your lender only cares about protecting against hazards,[1] but along with protecting your equity you should cover your personal property, including furniture, appliances and clothing, and most importantly you should have coverage for personal liability for injuries to others or property damage you or members of your family cause to others. If the bank takes out the insurance policy for you, they are only going to take a hazard policy.

Courtney:      Can you elaborate for our readers the different types of coverage available under a standard homeowner’s policy?

Mike:              Homeowner’s insurance is broken into two main parts: one – property coverage, and two – liability/medical coverage. Property coverage provides coverage for the dwelling itself, any detached structures, the contents on premises and even some contents off premise. Whereas, liability and medical coverage provides coverage in the event you or your family cause bodily injury or property damage or if someone gets injured on your property.

Courtney:      Okay, now that we know what types of coverages are available, can you provide our readers with examples of the various types of events/occurrences that they would be protected against under such a policy?

Mike:              Under the Standard Homeowner’s Insurance Policy also known as HO-3 or Special Form you will see the following losses covered:[2] fire, lightening, wind, hail, explosions, glass breakage, smoke, theft, weight of ice and snow, vehicle damage, overflow of water from appliances, freezing, electrical damage, heating system loss, ice back up, spilled chemicals, overhead appliances, dropped objects, accidental damage, damage by aircraft, and vandalism.

Courtney:      Mike, what are some factors that affect homeowner’s insurance premium rates?

Mike:              Factors that affect premium rates are as follows:

• Credit– Insurance Carriers will run Insurance Credit Scores. These are slightly different than a traditional credit report but scoring is done very similar. The one difference is the insurance score doesn’t affect your hard credit score rating.

• Location – Some insurance companies use data to determine which neighborhoods have more claims than others, and they increase their rates accordingly. They may also look at the distance of your home from the nearest fire station and fire hydrants.

• Home Age, Features and Materials – The age of your home, property features and even building materials can affect how much coverage you need to carry which affects your premiums. Certain features of your home (regardless of its age) may your homeowner’s insurance. These include swimming pools, trampolines, and wood stoves.

• Whether House Has Been Updated – Many older homes tend to develop problems with electrical wiring, plumbing, and foundation, more frequently than newer/updated homes. Some renovations to ward against common problems may keep your insurance down.

• Claims – For current homeowner insurance policies, the frequency of your claim record will translate into higher rates. Carefully evaluate every claim before submitting it for reimbursement. Ask yourself whether the claim is worth risking a hike in your premium next year. Preventive maintenance and keeping up with small problems, may prevent larger and more costly ones in the future.

Courtney:      Mike, I think one of the most confusing things for homeowners to understand is the difference between Replacement Cost versus Appraised Value or Purchase Price. Mortgage lenders require my clients to carry full “replacement cost.” What does this mean, and what do our readers need to know?

Mike:              Replacement cost is the amount of money it takes to replace a structure with a similar type of construction, an expense which can vary from year to year. When real estate markets are appreciating, it can often cost more to buy a resale or used home than to build a new home. But when markets decline, it is often cheaper to buy an existing home than to build new. We use a specialty tool to calculate the replacement cost of a property. We use factors like square footage, year built, style of the house, etc. to calculate what it would cost to rebuild the property the same way at present day construction prices. As such replacement cost can be more than your purchase price or appraised value. If it costs more to build a new home than the initial expense of your home, then you will want to make sure the replacement cost coverage of your policy is higher than the price you paid. If prices are appreciating in your neighborhood, you may also want to increase your basic insurance coverage but the replacement cost coverage might go down.

Courtney:      Co-insurance or replacement cost penalty are also common insurance terms that are very confusing to my real estate clients. Can you break it down for us in layman’s terms?

Mike:              Built into insurance contracts is a clause known as coinsurance or replacement cost penalty. Think of property coinsurance as a warranty or condition of the policy.  The coinsurance states what percentage the insurance you are carrying bears to the value of the property you are insuring.  The value must be either actual cash value (current market value) or replacement cost (cost to rebuild) depending on the policy you have selected. At the time of a loss, the coinsurance clause comes out of the dusty regions of the policy to be activated. If the policy has 80% coinsurance, the insured must be carrying an insured amount that is NO LESS than 80% of the value of the property at the time of a loss.  If the amount carried is at least 80% or greater of the value of the property, the insured is paid 100% of his claim (not 80% as so many buyers think) and everyone is happy. If the amount of insurance that is actually being carried is less than the 80% shown above, the coinsurance clause fires up.  In property insurance language, “coinsurance” means that you are accepting a role as a co-insurer in the event of a loss and are willing to take less than the full claim amount.

Courtney:      Can you give our readers any tips on choosing the right insurance agent to avoid insurance coverage gaps?

Mike:              Insurance agents play an important role in the insurance marketplace. Insurance policies do not provide “peace of mind” if they have gaps in coverage that leave policyholders without benefits following a loss. Accordingly, insurance agents who promise to work and advise insurance customers of their options should be selected over those that promise to obtain “cheap insurance.” These agents recognize their obligations to customers extend far beyond being mere order takers and providing the cheapest insurance premium. Instead, they are the agents who procure insurance policies which provide the “peace of mind” the insurance industry promises and advertises to those who purchase its products.

Courtney:      Thank you, Mike!

[1] Hazard insurance typically does not cover earthquakes, floods and certain other catastrophic events. Your lender may require you to buy the additional — and often expensive –coverage if you live in an area susceptible to such hazards

[2] All Losses need to be sudden and unexpected.