3 boxes to check before you buy homeowners insurance, according to a financial planner

© Martine Beher Photography
The author, CFP Malik S. Lee. Martine Beher Photography

  • Whether you’re getting homeowners insurance for the first time or just updating your policy, there are three boxes you need to check before signing on the dotted line.
  • First, be sure your policy covers all your valuables, from your jewelry and cash to your deeds and letters of credit.
  • You should also purchase enough insurance to cover the replacement cost of your home (or slightly more) and consider getting an umbrella policy to cover personal liability.
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For most families in the United States, owning a home is an essential part of the American Dream. And even amid a global pandemic, the data suggest that that particular dream is alive and well.

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In July 2020, the US Census Bureau announced that the homeownership rate is at 67.9%. As of 2019, individual homeowners were estimated to own nearly $29.2 trillion in real estate and over $18 trillion in home equity.  

These numbers indicate that for homeowners, their property likely plays a massive role in supporting their net worth. That makes your home a critical asset that you must protect. 

Here are my three pieces of advice to follow to ensure that your homeowners insurance policy is providing efficient protection for a significant piece of your wealth.  

Make sure your policy covers all of your valuables

One of the many benefits of having a homeowners insurance policy is the added protection for your personal property. 

Most policies will protect possessions like clothing, appliances, furniture, tools, and decorative items from a covered loss or theft. They also usually cover up to $200 in cash or cash equivalents (bank notes, bullion, gold, and other precious metals); $1,000 to $2,000 in jewelry, watches, and furs; and $1,000 to $2,000 in other assets (securities, deeds, etc.). 

While your policy can cover certain personal items such as physical cash and jewelry, as well as assets like securities, deeds, and letters of credit, this protection only extends to a certain limit. 

To ensure that all of your personal property is completely covered through your homeowners insurance, you may want to purchase a special personal property endorsement or floater on your insurance policy. 

Not only will this expand the coverage protection for your valuables, but it will cover you from personal negligence, such as leaving jewelry in a restroom. 

Ensure that you have adequate replacement cost

As a certified financial planner, one of the most common mistakes I see people make is insuring their home for what they think their home’s market value is. The correct way to insure your property? By full replacement cost.

Replacement cost is the amount needed to replace or repair your entire home should an insured event (like a fire or natural disaster) occur and cause severe damage to your property.

Insuring your home based on the replacement cost value will protect you from labor, materials, and transportation expenses required to rebuild your home back to its original state. 

In contrast, insuring your home based on market value will not only take those factors into account, but will also include other factors such as schools, crime statistics, location, and demand. These added considerations can leave you with a policy that doesn’t match the true replacement cost of the house, which can impact the premiums you pay.

Using the replacement cost method to insure your home is not something that you set and forget. The replacement cost coverage is something that you should review on an annual basis.

LaTanya G. Simmons, vice president and private risk advisor for Aon, recommends consulting a personal risk management professional who uses proprietary estimator tools to calculate the replacement cost of your home. These tools incorporate factors such as the location of the home, year built, square footage, and unique features.  

Simmons also mentioned that high-net worth carriers go a step further to confirm replacement cost by dispatching appraisers to visit and walk through the home. That allows professionals to document precisely what the home includes, which makes it easier to rebuild accurately with the same kind and quality of materials in the event of a loss.

You may also want to consider a homeowners insurance policy that includes a feature called extended or guaranteed replacement cost. This can help ensure your replacement cost keeps up with inflation, goes past the replacement cost amount (i.e. 10% or 20%), or even allows you to rebuild the home with no limits on costs on guaranteed policies.   

Supplement your liability coverage with an umbrella policy

Your homeowners insurance policy has some degree of protection against personal liability claims. If, for example, someone trips and falls on your property and then sues you, or your pet causes injury to someone else on your property, liability coverage will cover the cost to defend you in a court of law.

Generally, your personal liability coverage through a homeowners insurance policy will be somewhere between $100,000 and $500,000. That may be enough in coverage, unless you have a higher net worth or what we might call “attractive nuisances” on your property that could invite mishaps: think pools, trampolines, treehouses, ATVs, or dogs.

In that case, additional liability coverage through an umbrella insurance policy might be wise.

Umbrella insurance is a separate, stand-alone policy that can cover expenses above your existing personal liability insurance coverage. It adds an extra layer of protection to help you avoid financial hardship should a significant accident occur. 

Coverage limits on umbrella policies typically start at $1,000,000, and in most cases go as high as $5,000,000. Although most people might think these amounts are excessive, some experts estimate that over 10% of personal injury liability awards and settlements hit the million-dollar mark. 

There’s a quick and straightforward method for determining the right amount of umbrella coverage: subtract your respective liability coverage limit from all assets at risk, including home equity, personal property, investments, and savings. 

If you get a negative number, you’re in a potentially risky situation and may need additional protection. It’s probably a good idea to consult with an insurance specialist or a certified financial planner to confirm your calculation. 

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