Every year I review my home insurance policy to make sure I’ve got the proper coverage. The reason why it’s important to check is because insurance policies change all the time. There might be discounts or special offerings for one. Meanwhile, your insurance company might slip in some extra charges without you even knowing. Finally, and perhaps most importantly, building costs are always rising thanks to inflation.
One of the worst things that can happen after a mishap is your home insurance policy covering much less than the true replacement cost. Even if your home appreciates by only 2% a year, if you don’t update your home insurance policy for 16 years, your policy will only cover half the rebuild cost! Let me share with you one of my rental property insurance mishaps and things you should think about when figuring out how much home insurance to get.
MAKE SURE YOU ARE COVERED
About three years ago, one of my rental’s master bathroom floors started leaking water into the unit below. It was such a mess that for a couple months you could literally see through my bathroom floor into my neighbor’s bathroom. I had been meaning to remodel my 30 year old bathroom for a long time, so I never thought about getting landlord insurance.
I figured I’d just rip everything out on my own dime once the tenant moved out. Of course, the bathroom disaster happened just two months before my tenants departure! I was making a healthy income back then, which allowed me to cover any and all damages without a problem. Having money made me careless with my assets.
Redoing the bathroom and fixing the damages caused by the leak cost me around $8,000 bucks. I went the “good enough route” with mid-end Home Depot material given it was a rental. If I was smart, I would have had insurance to cover everything but a $1,000 deductible and get a sweet $25,000 bathroom instead. Only after spending $8,000 did I do my research on home insurance and get a policy. What a double whammy to my bank account.
FACTORS INTO FIGURING OUT HOW MUCH HOME INSURANCE TO GET
* Monthly cash flow. The more insurance coverage you get, the higher your monthly premium. I personally would not pay more than 2% of the total monthly cost to insure your property. For example, let’s say it costs $2,000 a month to own your home, including property taxes, HOA dues, etc. I’ve got a rough gauge to spend roughly $40 a month, or $480 a year in home insurance.
* Market value. It’s important to get coverage as close to market value, plus a couple percent buffer just to be safe. You can find comparables by checking out the latest sales on Zillow.com. Once you punch in the address you’ll see home estimates, previous sales prices, and comparable listings to make sure the appraised value given by your insurer is in the ball park.
* Differentiate between building and land value. A lot of people mistakenly think it’s best to get insurance on the total value of the property. The main focus for home insurance is replacement cost of a similar quality home. For example, let’s say a comparable house sells for $500,000 down the street. The house is 1,500 square feet and sits on 10,000 square feet of land in Oregon. It costs an estimated $200 a square foot to rebuild the house, equating to $300,000. The land value is therefore around $200,000. The home insurance should be based on building $300,000 worth of home. If a flood wipes out your house, your land should still be there so it costs next to nothing to replace.
* Estimate the various deductibles. Insurance companies will offer various deductible levels in case a claim is made. For example, you can have a deductible as a percentage of the rebuild cost of your home, a $1,000 deductible, $2,000 deductible, $5,000 deductible and so forth. If your home is in a hazard zone that contains Brazilian cherry wood floors, a top of the line range, gold fixtures, and custom windows that cost a fortune to replace, you might want to get a lower deductible. You don’t want to feel like you are wasting money, but you want to be able to sleep well at night.
* Consider disaster insurance. Disaster insurance is an extra layer of insurance for those properties in hazard zones such as earthquake, fire, flooding, and landslides. If you are in a high risk zone, please read this post I wrote on how to decide whether you should or should not get disaster insurance for your property. Given I live near a fault line, I think about this topic every time I call my insurance company to check up on the latest.
* You can always change your deductible. If six months down the road you feel you are paying too high a monthly premium, call up your insurance agent and raise the deductible to lower your monthly premium. If you go with a reputable insurance company like AllState or USAA, you shouldn’t have any problems. Don’t be afraid of being locked in.
* Understand what the condo association will and will not cover. If you are a condo owner, the master association insurance policy generally covers all damage to the building other than to your property. Your insurance coverage is generally referred to as “walls-in” or “studs-in” coverage. You shouldn’t be liable for any damage outside your walls, and your association isn’t going to pay for anything that happens in your walls. There is a lot of contention here because what if you have a main pipe that is between your wall and an outside hallway wall that bursts and ruins the structure? It’s important to simply ask your HOA board members and the respective insurance companies what is and is not covered.
* Loss of rent and tenant liability coverage. A comprehensive rental insurance policy should have loss of rent coverage for a certain amount of months, as well as tenant liability coverage. It may take six months to fix your place and find a suitable tenant again. Your agreed upon policy will keep the cash flow coming in. You also never know what your tenants are up to. If they accidentally set your place on fire, which ends up damaging the upstairs unit, you need to have enough insurance to cover such freak incidences.
* Pulse check. Reputable insurance companies tend not to rip you off as much. At the end of the day, you need to get enough coverage which makes you sleep better at night. If you only want to cover 70% of your rebuild cost because you want to save on premiums and have the other 30% in liquid cash to rebuild on your own, then go for it. If having anything less than 110% of the rebuild cost gives you nightmares, then go for that policy as well. I just wouldn’t get too little coverage, or get coverage that provides more than 125% of replacement cost.
* Shop around for insurance. The internet makes it easy for consumers to shop around for home insurance. I’ve had a good experience with AllState, where you can click the link to search for an agent by zip code, name or city. They consistently have some of the cheapest rates with the most comprehensive policy. USAA is OK, but I had a really wonky experience with them in the past where they raised my premiums by a whopping 45% one year! I had to fight them to stop being ridiculous and eventually got them down to a more reasonable 15% increase instead. Do what we all do when buying anything online, get an actual quote, and call another provider and see if they can match or beat your first offer.
Make sure your property is not only covered, but optimally covered where you aren’t overinsured or underinsured. Property is already an illiquid asset that cannot be easily monetized in case of an emergency. The last thing you want to do is lose your job and have an unfortunate mishap in your home without having any money left over.
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Updated for 2016 and beyond.