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Purchasing a new home is always a huge deal in one’s life since it symbolizes years of hard work, perseverance, discipline, and finally enjoying the fruits of one’s labor. Most people spend countless weekends visiting open houses and comparing mortgages and interest rates in a bid to secure a loan to finance their dream abode. However, when buying home insurance, many buyers think of it as a mere formality that needs to be ticked off on the checklist and signed without further ado. But that would be a grave mistake, which could result in dire consequences later on.
The American insurance market is constantly changing due to rising inflation, increased costs of construction, and altered weather patterns. As a result, the value of properties is rising, and many people are becoming exposed to unprecedented risks. The insurance policies they used to have might become irrelevant in the context of modern-day risks. Therefore, to ensure their financial stability and avoid serious losses, new homeowners should know some common home insurance mistakes that many people tend to make. Below are the eight most widespread errors first-time homeowners can make when purchasing their first-ever insurance policy.
Confusing Market Value with Replacement Cost
One of the most frequent missteps new homeowners can make concerns their home’s market value and the price needed to reconstruct it entirely from scratch after a catastrophe occurs. Suppose you purchase a house for $450,000. In that case, it might seem logical to purchase a policy covering a home worth $450,000 in case a fire breaks out and destroys it. However, doing so would be a terrible idea since you would end up being seriously underinsured.
Market value and replacement cost are two concepts that are entirely different in meaning and should not be confused. Market value refers to what a willing buyer will pay a seller to acquire the home at the current moment. The price of the property depends on various factors, including its location, its distance from major urban centers, the quality of nearby schools, and the value of the land itself. On the contrary, replacement cost is about how much money a homeowner needs to reconstruct their home after a total loss.
For example, if a homeowner’s house burned down or was destroyed by a hurricane, they will still have the very same land underneath it, which means the insurance company does not need to pay them for it. Meanwhile, depending on whether or not the area of the property is expensive for construction purposes, the cost of replacing a ruined building might exceed its market value. That is why first-time homeowners should consider purchasing an additional coverage layer and never base their insurance policies only on the property’s market value.
Choosing a Deductible You Cannot Afford
New homeowners’ priority is to reduce their mortgage payments, which usually include their home insurance premium. Hence, it makes sense to purchase a policy that will require them to pay as little as possible each month. However, to achieve that goal, many buyers tend to select a maximum deductible, which allows for lowering the monthly payment but puts them at great financial risks in case something happens. For instance, if a person chooses a $5,000 deductible, they will have to cover the first $5,000 of damage before receiving any funds from their insurance company.
Another problem first-time homeowners need to pay attention to is specific hazard deductibles, which are prevalent in different regions. In areas prone to hurricanes, hailstorms, or earthquakes, many companies charge a certain percentage as a deductible, and it does not matter whether the homeowner’s house has been severely damaged or is virtually intact after the event. For instance, in Florida, insurance companies can charge 2% as a windstorm deductible on a house costing $400,000. In such a case, if something happens to the property, the homeowner will have to cover 2% of the house’s cost out-of-pocket, which amounts to $8,000.
Therefore, choosing a deductible that suits one’s budget is crucial since otherwise, the owner will be unable to finance the rebuilding process and will stay homeless until they manage to gather sufficient funds. Moreover, many people underestimate their deductibles since they are unlikely to happen, but in times of trouble, their insurance will not be able to cover the expenses and assist them in restoring the property.
Assuming That Flood and Earthquake Damage Is Covered
Homeowners insurance or HO-3 provides comprehensive protection for a home and its contents in case of numerous hazards such as fire, lightning, explosion, vandalism, theft, falling objects, etc. Given that the list of covered events is exhaustive, people often believe that they will be financially protected if any other calamity happens. However, that assumption is completely wrong since the policy explicitly excludes several disasters, including floods, rising water, and earth movement.
To ensure that one’s home and belongings are protected against the listed threats, people should purchase additional policies that will guarantee their safety in case of such disasters. To protect one’s property from flooding, one should acquire a separate policy through the National Flood Insurance Program or another private carrier. Although many homeowners neglect the need to purchase flood insurance since their mortgage lenders do not force them to do so, they still need to do it. Every year, the USA experiences heavy rains, rapid snowmelts, or inadequate drainage systems, which cause extensive flooding. Even though one may not live in a special flood hazard zone, floods still can occur.
As for earthquake insurance, people who own homes in California should definitely look into getting additional coverage. Still, owners of properties located in the Midwest or the Pacific Northwest should also think about adding an earthquake insurance endorsement to their policy, especially if they live near any seismic activity. Otherwise, they will remain unprotected from catastrophic events.
Neglecting the Importance of Water Backup Coverage
Although standard insurance policies exclude damage caused by overland flooding, they do not cover cases when a property’s sewer or drain system fails to function properly. Many people mistakenly believe that such a case would be covered under the plumbing system, but that is not true. In case the homeowner’s sewer line breaks down due to excessive rains or snow melts, and raw sewage starts leaking into their basements, they would not be entitled to compensation.
Repairing a basement backed up with sewer water is a complicated procedure that requires a professional cleanup, removing drywall, and sanitation services. Such a project can be quite expensive, and a homeowner may lose up to $30,000 covering those expenses. However, fortunately, there is a simple and affordable solution to that problem – one should purchase water backup coverage or add the corresponding endorsement to their home insurance policy. It will cost homeowners relatively low annual premiums, but it can save them from significant expenses in the case of a mishap.
Underestimating the Value of Personal Belongings
During the final walkthrough of an empty home, a first-time buyer would hardly imagine how much stuff they will accumulate in that house. Thus, when purchasing home insurance, they usually go with what the insurance agent suggests – a predetermined percentage of coverage for personal belongings. They fail to assess the aggregate value of all their furniture, electronics, clothing, kitchen appliances, tools, and other property, considering their possessions to be worthless.
Still, if something happens to their home, such as a fire outbreak or structural collapse, they will have to replace everything they owned within a short period. Moreover, a policy’s personal property coverage has internal sub-limits concerning some categories of luxury goods. For instance, most policies limit payments for jewelry, musical instruments, sporting goods, and artwork at $1,500. Thus, homeowners need to explicitly schedule their valuable belongings by informing their agents of their ownership. Otherwise, they might end up with nothing after a disaster.
Overlooking Liability Limits and Umbrella Policies
Homeowners insurance is not only supposed to compensate for property damage. In addition to that, it is meant to protect homeowners against lawsuits. In other words, if somebody gets injured inside or outside the owner’s property due to his or her negligence, they might sue them. The insurance policy will pay for those people’s treatment, legal costs, and other losses. Still, the problem lies in that the insurance companies usually provide their clients with minimal personal liability limits, such as $100,000.
Nevertheless, nowadays, people can easily get injured and incur massive medical bills that can reach millions. In case one’s liability limits are depleted, they will have to pay all those expenses from their own pockets. In turn, people can sue homeowners for millions of dollars, claiming that their actions or negligence have caused injuries to the victims. However, that issue can be easily solved by increasing one’s liability limits up to $300,000 or even $500,000.
Alternatively, homeowners can purchase an umbrella policy, which would extend their liability limits for a small annual premium. Thus, their personal liability limits might be as high as $1 million or $2 million, which would give them much-needed security. Still, homeowners need to remember that even though an umbrella policy is quite cheap, they should carefully assess their liability risks before acquiring it.
Skipping a Thorough Digital Home Inventory
Moving into a new house entails lots of activities, which might distract homeowners from conducting a thorough inventory of their belongings. However, this task is extremely important in case of a disaster that requires filing a property claim. It will be almost impossible for homeowners to memorize everything they owned in their closets, dressers, drawers, etc., while experiencing tremendous emotional stress after a fire outbreak or tornado.
To ensure that people will receive appropriate compensation for their lost property, insurance companies will demand a list of all the belongings homeowners owned in the affected area, as well as their serial numbers, brand, and prices. If homeowners cannot provide all this information, they will have to settle for generic item replacements, which will be much cheaper. To avoid such an outcome, homeowners need to create a digital video inventory of their belongings, focusing on all the rooms of the house, particularly basements and attics.
Failing to Shop Around and Review Policies Annually
Many people rely on recommendations made by their realtors and mortgage brokers when buying home insurance. Although these suggestions might prove to be helpful, people need to shop around for better options. Usually, different insurance companies use distinctive proprietary algorithms to determine homeowners’ risks, which results in diverse prices of comparable policies. For instance, the cost of insuring one particular suburban house can differ by hundreds of dollars among competing companies.
Another common mistake involves ignoring the need to update policies annually. One should conduct a thorough review of their home insurance policy each year to ensure that all of their risks are appropriately covered. Moreover, homeowners should discuss with their insurance brokers how their risks have changed throughout the year. In case they have renovated their home or purchased a pool or a trampoline, their insurance policies need to reflect those changes.
Frequently Asked Questions
Questions: Is There Any Difference Between Actual Cash Value and Replacement Cost?
When it comes to property insurance, there are two types of valuation methods: actual cash value (ACV) and replacement cost value (RCV). The former compensates for property damage by paying the price needed to replace the lost item minus accumulated depreciation based on its age and condition. The latter guarantees compensation for purchasing a new replacement item without subtracting anything for depreciation.
Replacing items using ACV would be much cheaper for insurers, which is why most people prefer to cover their belongings using the RCV method. However, there is a possibility that insurers will refuse to pay the RCV in the case of a disaster. In such a situation, homeowners would have to buy a new item using their funds. That is why people need to purchase a policy that will guarantee RCV.
Questions: Does a Home Security System Affect My Home Insurance Premium?
A home security system plays a crucial role in reducing the likelihood of theft. Not only does it scare burglars who try to break into one’s house, but it also alerts emergency services promptly, allowing them to arrive on the spot quickly. That way, homeowners minimize any losses in case of fire outbreaks or other emergencies. In light of that, most insurers are ready to grant discounts to people who installed a monitored smart home security system.
Additionally, homeowners can obtain discounts for having smoke alarms and water-leakage detectors. However, they need to remember that discounts will only be granted if they notify their insurance companies of having these security measures in place.
Questions: Will My Home Insurance Policy Cover My Dog if It Bites Someone?
Most homeowners’ insurance policies contain provisions concerning liability coverage, which covers any incidents that might happen outside and inside one’s property. Among other things, liability insurance protects homeowners against lawsuits if their dogs bite somebody. However, people need to be aware that some insurance companies have exclusive lists of dog breeds that pose a threat to their clients. Thus, in case one owns such a dog, he or she needs to inform their insurer of that fact.
Questions: Do I Need to Purchase Flood Insurance If My Mortgage Lender Says I Do Not Have to?
In general, homeowners are not forced to purchase flood insurance, unless they live in a federally designated special flood hazard zone. However, this type of insurance is highly recommended even in low-risk areas since a significant percentage of flood claims happens in special zones. That said, people need to take this issue seriously and look for opportunities to reduce their risk of suffering from unexpected damage and losing their property.
Questions: Can I Change My Home Insurance Provider After Closing on the House?
Certainly, people can change their insurance carriers whenever they want. They do not need to wait for their policy’s expiration date or renewal to switch. In case they decide to change their home insurance carrier, the new insurance company will contact their mortgage lenders to transfer funds to the escrow account.