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How Does Homeowners Insurance Work?

Key takeaway

Homeowners insurance helps protect you financially if your house is damaged, its contents are stolen, or if someone is injured on your property. Title insurance and private mortgage insurance are other types of insurance that may help protect you and your lender.

Your future home is likely to be the most valuable thing you own, and insurance is a way to protect this major investment — and help you feel more financially confident. For example, insurance could pay to repair major damage to your home or even replace your home if it’s destroyed.

During the homebuying process, your mortgage lender may require you to have different types of insurance. You may also choose to have optional insurance coverage for your — and your family’s — comfort.

Here are the three most common types of insurance to know about.

1: Homeowners insurance

Covering your house, its contents, and protecting your finances if someone is injured on your property

What it is:

Homeowners insurance covers specific aspects of your property, as well as belongings you keep in your home. It also may help protect you financially if a person is injured on your property.

Details of what’s covered can vary, but homeowners insurance can cover the costs of repairs due to fire, snow, wind, hail, frozen plumbing, vandalism, or theft. It might also cover the costs of a temporary place to stay while your home is being repaired.

Some types of damage related to floods or earthquakes may not be covered unless you specifically add it to your policy. If the home you’re buying is located in a flood- or earthquake-prone zone, you may need to secure additional coverage specific to floods and earthquakes.

Homeowners insurance also covers the value of belongings you keep in your home — everything from your clothes to your furniture — in case these are damaged, destroyed, or stolen. If you own something very expensive, like a diamond ring or a grand piano, you can get it appraised, recorded, and covered specifically in your policy.

How it works:

If your home is damaged or burglarized, or if someone injured in your home is asking you to pay medical bills, you can submit a claim to your insurance company for what it would cost to fix the damage, replace any belongings, or compensate the injured person.

If the claim is approved, you typically have to pay a deductible amount, which varies from policy to policy. Then the insurance company pays you, the repair company, or the injured person the rest, as outlined in your policy.

What else to know:

Homeowners insurance prices and policy details vary significantly from provider to provider; shop around and understand exactly what each policy covers so you can make a fair comparison. Read more details about claims, repairs, and how homeowners insurance works.

2: Private mortgage insurance

To help lenders give more people access to home loans

What it is:

Private mortgage insurance (PMI) is designed to reimburse your mortgage lender if you stop making payments on the home as agreed.

PMI is typically required if you’re buying your home with a conventional loan but are making a down payment of less than 20% of the purchase price.

PMI protects the lender, so they are more willing to extend loans to people without the standard 20% down payment. (Remember, there may be other ways to get a home loan with a down payment amount of less than 20%.)

How it works:

Most lenders add PMI to your monthly payment in the form of a premium.

Some may require you to pay PMI in full when you close on your home. Make sure you know how much your PMI costs will be so you can come to your closing prepared.

What else to know:

If you can show that your home has increased in value, or you have paid down your loan balance enough, you may be able to request that your lender remove the PMI from your loan. Typically you will need to have 20% equity (the difference between the market value of your home and what you owe on your mortgage) in your home.

This should help decrease your monthly payment. Lenders are required to end your PMI obligation when you have 22% equity in your home.

3: Title insurance

To protect yourself and your lender against lawsuits and liens

What it is:

During the homebuying process, homebuyers are also required to purchase title insurance. Title insurance is an insurance policy that protects your lender against loss resulting from a title error or dispute.

Title insurance protects you and your mortgage lender against possible financial losses that could occur if someone tries to claim they own the property you’re purchasing or if there are unresolved liens on the property.

Pronounced “lean,” a lien is a legal claim filed against your property by a creditor. This could be for unpaid government taxes, child support, or renovation costs. The lien issuer may be entitled to repayment of that bill before you can own the house.

How it works:

The title insurance process takes place before you finish purchasing a home. Instead of being collected and paid over time, title insurance is paid in full by the buyer when your loan closes. Coverage is issued for the amount equal to the loan until it’s repaid.

A title company or an attorney can make sure the seller has the right to sell the property, that there are no unresolved liens, that no family members claim they own some or all of the property, and that there are no other issues that could impact your ownership in the future.

A separate policy called owner’s coverage can also be purchased to protect the homebuyer from this loss.

The title company and attorney work to resolve any title issues, and then they apply for title insurance. The policy covers the costs of any lawsuits should anyone challenge the title, and it’s purchased with a one-time payment.

What else to know:

Your home mortgage consultant, Realtor, or attorney can all suggest title companies for you to consider.

This is another time when you can compare rates and fees for the services offered.

Related articles

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Homeownership and taxes: What you need to know

Understand the potential impact that owning a home has on your taxes to manage these expenses (or tax breaks) successfully.

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