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Purchasing a house is a life-changing experience, especially if it marks the end of years of work, careful saving, and countless trips to Saturday open houses. In all the rush with comparing interest rates, bargaining with the seller about concessions, and choosing paint shades, it is extremely easy to take insurance policies lightly, as one of those annoying things required to finally get the keys. Most first-timers call the first insurance agency they find, tell them about your mortgage lender requirements and sign a contract on the spot.
However, you should think of insurance as of a necessary part of the process rather than some annoying detail, as the American real estate landscape is now becoming much more complex than it used to be, featuring unpredictable weather conditions, rampant inflation, and constantly growing costs of constructions, among other factors. A single mistake on your part during insurance selection and purchase might lead to devastating effects on your wallet. Here are ten most common errors that can turn into a disaster for a first-time homeowner.
1. Confusing Market Value With Actual Replacement Cost
One of the worst mistakes that new home buyers tend to commit is a fundamental misunderstanding of the replacement cost vs. market value. People expect to insure their $450,000 property for $450,000 since it was the price that they paid. The thing is, insurance companies do not work with this logic; instead, they calculate a property’s replacement cost, i.e., the amount required to rebuild the home from scratch, disregarding the value of the land.
Market value, in its turn, is the amount that a willing buyer would pay to a willing seller in the current real estate market. The market price largely depends on such factors as the popularity of the neighborhood, quality of local schools, proximity to a city center, and the value of the land itself. On the other hand, if you live in a historical area or a high-construction-cost region, replacing your home from scratch can actually cost more than purchasing it.
2. Selecting a Non-Affordable Policy Deductible
If a buyer is desperate to reduce the monthly mortgage rate, he or she will gladly agree to select the maximum deductible that the policy offers, without thinking about possible risks. Indeed, choosing a high deductible helps you save some money every month, but it does not mean that you are protected in case something happens. In addition to regular property insurance, you might face special hazard insurance and a high percentage of deductibles in areas with hurricane and hail risks.
If your home insurance policy has, say, a 2% windstorm deductible and the price of your property is $400,000, you should pay $8,000 out of pocket before receiving the first cent from your insurance company. Without making sure that you have a sufficient amount of money on your emergency bank account, it is hardly possible to survive such a situation.
3. Believing That Flood Damage Is Covered By Basic Insurance
Standard homeowner insurance policies (HO-3) feature an extensive list of events that are covered by the contract, such as fire, explosion, theft, and lightening strikes. This makes people believe that any other disasters can be added to the list of protected situations. As a result, many new homeowners ignore the importance of having a dedicated flood insurance plan, which is a huge mistake.
Standard insurance policies do not cover such risks as rising surface water, mudflows, flash floods, and earth movement. The best way to secure your property is to buy a dedicated flood insurance plan from a specialized insurer or from the Federal Emergency Management Agency. Even though your lender might not require you to purchase flood insurance, it does not mean that you do not need it.
For example, there might be many small lakes nearby, which will flood your property in case of a heavy rainfall. It is not uncommon for a homeowner to underestimate this risk because of a lack of knowledge, as most people know the risks associated with living in a Special Flood Hazard Area.
4. Neglecting Water Back-Up Coverage
Although your basic homeowner insurance plan does not provide flood damage coverage, it is expected to handle any other events related to the occurrence of water in the house. However, standard contracts often feature an exclusion for sewer and drain coverage, which means that if you experience problems due to an overcharged sewer line, you will have to pay for all the damage yourself.
For instance, during a heavy summer rain, the sewer line that goes to your property gets clogged, which leads to massive amounts of sewage water coming out of your basement’s drainage pipes. Repairing your basement, removing drywall, and restoring your property might easily cost you between $10,000 and $30,000, so having a dedicated water backup coverage is crucial.
The great news is that you can obtain water backup and sump pump overflow coverage for a nominal annual fee; however, many people do not consider this option. In order to save a few bucks on your monthly insurance rate, people neglect the possibility of getting an additional rider to their contract.
5. Overestimating Personal Property Insurance
As soon as you visit an empty home in order to finalize the deal, you do not really think about how much junk you are going to move here. Instead, people take a default policy provided by their insurance agent, which includes some percentage of dwellings insurance. Most people simply do not want to spend any time counting how much the entire set of belongings might actually cost.
This problem reveals itself as soon as people suffer a fire in their house or any other disaster requiring rebuilding. People might not think about how much it costs to replace the entire house furniture and appliances, let alone replacing clothes, shoes, and electronic gadgets, which might be difficult, too. At the same time, most personal property plans include special sub-limits on some high-value items such as jewelry and artwork.
As such, it might be important to explicitly name all such valuables in your insurance policy and provide proper appraisals in order to get appropriate coverage for them. Otherwise, you risk losing some of your most expensive belongings due to a fire or other disasters.
6. Overlooking Additional Liability Options
The thing is, home insurance not only protects your home. It also secures your assets against lawsuits if some guests were injured while being at your property. If your child or a pet causes some harm to a passerby in the street, your liability insurance will help to cover all legal expenses. Nevertheless, a standard policy will cover you only up to the minimum required limit, which is $100,000.
It is unlikely that a person with moderate assets will spend more than $100,000 treating a simple bone fracture or a broken leg. However, in case of a severe accident that resulted in hospitalization, the insurance company might run out of funds very quickly. At the same time, you will not be able to protect yourself anymore since your liability insurance will be exhausted.
If you do not want to become a target for a lawsuit filed by an injured party, you should raise your liability limit and get a cheap umbrella policy. This measure will allow you to protect a decent amount of your assets in the event of a lawsuit. Although raising the limit will increase your premium slightly, you will surely appreciate this step when a problem actually occurs.
7. Missing Out on an Essential Digital Home Inventory
Moving in and unpacking is a stressful moment for everyone, regardless of how well prepared they were. In addition to unpacking and arranging your belongings, you will need to create an inventory list of everything you purchased for your newly acquired home. Most homeowners do not care about creating a proper inventory at first; however, you might regret it someday, especially after a disaster.
It is extremely difficult to count all your belongings during a fire or after a tornado strike, not to mention all the psychological distress you might be experiencing during such moments. If an insurance adjuster comes to evaluate the loss, you will be obliged to give him or her an itemized list with all the information required for estimating the loss properly. Without it, your compensation might be dramatically lowered.
Therefore, it is crucial for a homeowner to make a detailed list of all his or her possessions before the first insurance audit takes place. One of the options is to film your entire property and store it in your cloud storage in case of emergencies. It will be much easier for you to show this footage instead of listing all your belongings manually.
8. Sticking with the First Provider and Not Reviewing the Policy
Many people decide to buy a policy offered to them by their real estate agent or mortgage broker. However, this does not mean that you should always follow their advice, as different insurance agencies use different algorithms in assessing risks. Therefore, the price for the insurance of the same property can differ by hundreds of dollars each month, not to mention that different companies might offer different plans.
At the same time, many homeowners do not realize that they might lose money in case of an unfortunate event, as their insurance plan is outdated. People who do not renew their plan every year might not know that prices on constructions have increased; as such, it becomes harder for them to reconstruct the damaged property. In order to protect your interests and avoid financial difficulties, you should discuss changes in your insurance policy with an independent specialist annually.
9. Overlooking the Difference Between RCV and ACV
Some new homeowners understand that it is important to protect their homes adequately; therefore, they purchase adequate plans. However, they often ignore another aspect of insurance, which is protection of their belongings. Some homeowners think that actual cash value of personal properties equals the replacement cost, but it is hardly the case in most instances.
ACV is the actual cost of repairing and replacing your belongings minus depreciation, whereas RCV is a price that would cost you today to acquire similar belongings. For example, if you bought a brand new television five years ago, and its cost was $1,000, it might only cost you $150 to get a refurbished version right now. As such, ACV does not provide you with a fair amount of compensation.
Choosing replacement cost option on your personal belongings is the only solution for getting proper coverage. While this might cost you a little extra each month, it will definitely help you to recover faster and get your home back to its original state. Therefore, you should always check whether your belongings are adequately covered.
10. Failing To Inform Insurance About Business or Risky Changes
Finally, you should always inform your insurance agency about any changes related to your house or activities in general. Starting a business at your home or adding a swimming pool might change the risk level dramatically. In case of an unfortunate event, your insurance company might deny claims because of material misrepresentation during underwriting, leading to a significant financial problem.
Most homeowners fail to disclose such changes in order to minimize their insurance premium; however, it is extremely unwise to do so. In addition to denied claims, you risk to have your home insurance canceled immediately.
Frequently Asked Questions
Question: How Is Replacement Cost and Actual Cash Value Different?
ACV is calculated as the cost of repairing and replacing your damaged property minus depreciation. RCV means the price required to buy a similar item or build a home nowadays using modern materials, without reducing the cost. While ACV helps you save a little money on the premiums, it fails to compensate for your losses after the disaster.
Question: Will A Home Security System Help Me Get a Discount?
Yes, if you add a monitored home security system, smoke detectors, and water leak sensors, your annual premium will significantly decrease. These measures protect your home from severe threats; therefore, an insurance company prefers to provide clients with such an opportunity.
Question: Am I Protected From Dog Bites?
Your standard home insurance will cover you in case a guest suffers from a dog attack both inside and outside of your property. However, many insurance companies feature a special breed exclusion list; as such, you should always discuss your pets with your agent.
Question: Why Do I Need Flood Insurance?
Although your lender might not ask you to purchase a special plan, it does not mean that you are protected in case of a flood. According to FEMA statistics, most homes located outside the Special Flood Hazard Area experience a flood during their lifetime. Buying a preferred-risk flood plan is an important part of securing your home from unexpected problems.
Question: Can I Change My Provider Anytime?
Yes, you have an absolute freedom of choice to change your provider whenever you wish. In case of early termination of a policy, your new insurance company will coordinate with your escrow and pay out your previous company the remaining premium amount.