How Much Homeowners Insurance Do I Need?

Homeowners insurance can protect you from financial disaster if your home or its contents are damaged or destroyed or if you’re sued because someone is hurt on your property. If you own a home with a mortgage, your lender probably requires you to have a homeowners policy. Even if you aren’t required to have one, it’s a very good idea.

But exactly how much insurance is enough? This article explains how to figure that out.

What Is Homeowners Insurance?

A standard homeowners insurance policy typically consists of several different types of coverage, each with its own dollar limits.

For example, a policy will generally cover:

1. The dwelling: This is the home itself and often unattached structures, such as a garage or tool shed.
2. Your personal belongings: Policies often cover your furniture and other possessions, both in your home and off-premises, such as items you take with you when traveling.
3. Liability: This coverage can provide financial protection if another person, or their property, are harmed by you or your pets.
4. Additional living coverage: This part of the policy can reimburse you for housing and related costs if your home becomes temporarily uninhabitable and you have to find another place to live for the time being.

These four types of coverage can differ from one policy to another, and you can choose how much of each you wish to purchase. We’ll discuss them in greater detail below.

What Homeowners Insurance Covers

A homeowners policy doesn’t protect you from every conceivable calamity. (In some cases, you may need to buy other kinds of insurance for that purpose.) But typically, it will cover financial losses related to certain specified “perils.”

According to the Insurance Information Institute, an industry trade group, the most common type of homeowners policy, known as HO-3, covers 16 specific perils. They are, to quote verbatim from the organization’s website:

• Fire or lightning
• Windstorm or hail
• Explosion
• Riot or civil commotion
• Damage caused by aircraft
• Damage caused by vehicles
• Smoke
• Vandalism or malicious mischief
• Theft
• Volcanic eruption
• Falling object
• Weight of ice, snow, or sleet
• Accidental discharge or overflow of water or steam from within a plumbing, heating, air conditioning, or automatic fire-protective sprinkler system, or from a household appliance
• Sudden and accidental tearing apart, cracking, burning, or bulging of a steam or hot water heating system, an air conditioning or automatic fire-protective system
• Freezing of a plumbing, heating, air conditioning, or automatic, fire-protective sprinkler system, or of a household appliance
• Sudden and accidental damage from artificially generated electrical current (does not include loss to a tube, transistor or similar electronic component)

While that’s a long list, the organization notes that policies typically “will not pay for damage caused by a flood, earthquake, or routine wear and tear.”

To protect against those risks, flood insurance from the National Flood Insurance Program (NFIP) is available through private insurers. In fact, mortgage lenders often require it for homes in flood-prone areas. Earthquake coverage is also available from many insurers, either as a separate policy or as an endorsement (or add-on) to a regular homeowners policy.

How Much Homeowners Insurance Do I Need?

Your lender, if you have a mortgage on your home, may specify a minimum amount of homeowners coverage that it expects you to carry. Otherwise it is your decision how much you want to have in homeowners insurance. You’ll want to weigh the financial risks you believe you face against the cost of insuring against them.

Here is a more detailed look at the four coverage types and how much coverage you might want to purchase.

Dwelling Coverage

Recommended coverage: Equal to your home’s replacement cost

Suppose your home burned to the ground in a fire or was flattened by a tornado. What would it cost to rebuild it, plus any other structures on your property, from scratch? That is your home’s replacement cost.

Bear in mind that replacement cost is not the same as your home’s market value, which is likely to be higher. For one thing, it doesn’t include the land beneath your home, which presumably survives intact.

Replacement costs can vary from one part of the country to another. An insurance agent or appraiser can help you estimate your replacement cost based on the home’s square footage and materials. There are also a number of calculators available online that will give you an estimate based on your ZIP code, although Investopedia hasn’t tested them and can’t vouch for their accuracy.

Some insurers offer guaranteed replacement cost coverage, which will pay to rebuild your home even if the cost exceeds the amount of coverage you purchased, such as due to an unexpected increase in construction or material costs. Others may offer extended replacement cost coverage, which covers the additional costs up to a certain percentage, such as 20% or 25%, of the policy limits.

However, in most cases, even guaranteed replacement cost coverage won’t reimburse you for any added expenses that are the result of changes to local building codes since your home was built. For that you may need to purchase an endorsement for your policy.

Personal Property Coverage

Recommended coverage: Enough to replace all your belongings

Homeowners policies generally provide coverage for your personal possessions, calculated as a percentage (such as 50% to 70%) of your dwelling coverage.

That may or may not be adequate, depending on what you own. If you have some particularly valuable items, such as a jewelry or artwork, you might want to insure them with an additional endorsement or floater.

Whatever you decide, it’s a good idea to make a written inventory of your possessions periodically, complete with photographs, to refresh your memory in case you ever need to file a claim. In the aftermath of a fire or other disaster, it is easy to forget everything you’ve lost.

Liability Coverage

Recommended coverage: As much as you can afford

Many homeowners policies come with at least $100,000 in liability coverage. That could come in handy if, for example, a visitor trips on your property and hurts themselves, your dog bites someone, or your old oak tree damages a neighbor’s car.

Depending on what happened—and how inclined the injured party is to sue you—$100,000 may not be enough. For added protection and peace of mind you can increase your liability limits or purchase an umbrella policy. It can supplement the liability coverage on both your homeowners and auto insurance coverage and help safeguard your other assets from a costly legal judgment.

Additional Living Expenses (ALE) Coverage

Recommended coverage: 10% to 30% of your dwelling coverage

If your home becomes unlivable, you will have to stay somewhere while it is being restored to normal. That might mean you may need a hotel or a short-term rental, for weeks, months, or even years.

Additional living expenses (ALE) coverage will defray part of those bills, including the cost of some restaurant meals, for a certain period of time. Bear in mind that it won’t pick up the entire tab, only the portion that exceeds your normal, pre-calamity living expenses.

ALE coverage is usually calculated as a percentage of your dwelling coverage, and it’s often 20%. If you don’t think that’s enough and want to increase it, you may have the option of buying more.

The Bottom Line

Homeowners insurance can protect you from serious financial losses if your home is damaged or destroyed or if you’re sued for allegedly causing harm to another person or their property. Whether or not you’re required to buy a policy, having one and checking the coverage limits periodically to make sure they’re adequate, is a wise move from a financial perspective.