More on Home Insurance
More on Home Insurance
Hazard insurance is term used by mortgage lenders to describe the section of homeowners insurance that protects the structure of your home.
When you take out a mortgage on a home, your lender will require you to get hazard insurance
Hazard insurance and homeowners insurance are not separate coverage types
The amount you pay for hazard insurance depends on a number of factors, including the age and build of your home
Hazard insurance is an oft-used term to describe the part of your homeowners insurance policy that protects the actual structure of the home from damage caused by hazards or perils covered by your homeowners policy.
You’re most likely to see this term when you’re closing on a mortgage for a home; your mortgage lender will typically require you to get “hazard insurance” to cover the property from expensive damage and to protect their investment. Your lender may also require that you pay for hazard insurance through an escrow account as part of your monthly mortgage payment—when your homeowners insurance bill is due, your lender pays the [insurance premiums] from your escrow account.
It’s important to understand that the lender’s priority, from an insurance standpoint, is seeing that the structure of the home is adequately insured. There are policies available that satisfy the lender’s bare-minimum coverage requirements—like a dwelling fire policy (DP1). But as the homeowner, you’ll want a robust home insurance policy with comprehensive coverage for your personal property and personal liability in addition to coverage for the home itself.
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Before you can officially close on a home loan, your mortgage lender will require you to pay closing costs and complete a number of other actions. This is referred to as conditional approval, meaning your mortgage has been approved—but you have a few other things to complete before it’s official.
Your conditional approval, or escrow conditions, include but aren’t limited to: signing a bunch of documents, paying closing costs, getting title insurance, and getting a homeowners insurance policy to cover your home against hazards. Your mortgage lender can also require flood insurance to protect the home from water damage if you live in a high-risk flood zone. If you have an escrow account with your lender, your insurance premiums will be paid for as part of your monthly mortgage payment.
When setting up your homeowners insurance policy, the insurance company will add what’s called a mortgagee clause or loss-payee clause to your insurance. What this clause does is add your insurance company as an additional insured on the policy, as they technically own a portion of your home.
If the home is damaged and you’re reimbursed for a claim, the insurance company cuts a check that’s payable to both you and the mortgage lender. Once the lender substantiates that the check is for the correct amount and it’s being used for the damage claim, they will endorse the check and you’re free to use the funds toward repairs.
Hazard insurance refers to the section of your homeowners insurance policy that provides coverage for the structure of the home—also known as dwelling coverage—against certain perils or risks indicated in the policy. The policy will also specify which perils are excluded from the policy. Perils that are usually covered by insurance include:
There are two main types of hazard insurance that will determine how broad your coverage is: named peril policies and open peril policies.
Named peril policies, or HO-1 and HO-2 policies, are the more inexpensive of the two, covering your home, detached structures on your property, and personal belongings from the perils explicitly listed in the policy (HO-1s typically cover 10 perils; HO-2s cover the 16 perils listed above).
Open peril policies, or HO-3 and HO-5 policies, cover your home from every peril except those explicitly excluded by the insurer. (The main difference between the two is that personal property is covered by named perils for HO-3, while HO-5 covers personal property with open perils.)
Fire, lightning and hail damage are some of the most costly homeowners insurance perils on average, accounting for around $45,000 per claim, according to the Insurance Information Institute. Wind and hail account for the most frequent homeowners insurance claims.
Earthquakes and floods aren’t covered by hazard insurance, but your company may offer flood or earthquake endorsements that you can add to your homeowners policy for an additional premium. If your insurer doesn’t offer earthquake or flood insurance, you can buy a standalone policy through another insurance company.
The amount you’re reimbursed for a hazard insurance or dwelling coverage claim is dependent upon what type of reimbursement provisions are in your policy. There’s actual cash value (ACV), which is the minimum amount of coverage in a homeowners policy, and replacement cost value (RCV) and extended replacement cost (ERC), which are both enhanced coverage options.
Actual cash value policies (HO-1s) reimburse you for whatever was damaged but only after depreciation has been deducted from the damaged property.
For example, if your house burns down, ACV coverage will reimburse you for the rebuild, but only after the years of wear-and-tear and depreciation has been subtracted from the replacement cost of your home. With ACV, you leave open the risk of going bankrupt with out-of-pocket repair expenses to make up the depreciation that the insurance won’t pay for.
For this reason, ACV policies are not recommended except as a last resort insurance policy.
Replacement cost policies (HO-2s, HO-3s, and HO-5s) are overall a safer bet, especially if your home is in an area with a lot of risk exposure. Like ACV, RCV policies cover the cost to repair or rebuild your house, but deterioration and depreciation value isn’t deducted from the rebuild amount; you’re simply reimbursed the amount that it’d cost to rebuild the home at the current prices for labor and materials.
Premiums are higher under RCV plans, but the enhanced coverage and financial protection is worth the higher monthly insurance premiums.
Extended replacement cost covers your home’s repair and replacement cost, but with the added guarantee that the insurer will cover any unexpected increase in costs to repairs (usually an increase of around 25-50% of your home’s dwelling coverage). If you live in areas prone to natural or regional disasters where labor or supplies could become temporarily scarce or expensive during the rebuild, ERC is a good option.
This level of hazard insurance isn’t required by lenders, but it remains incalculably valuable and sometimes necessary for people who live in areas that regularly experience natural disasters.
Homes that are only at risk of perils like fire, lightning, hail and wind damage may only need a basic amount of hazard insurance. Homes in areas that are susceptible to other costly perils, like flooding, earthquakes and mudslides may need to add separate hazard coverage, like flood and earthquake insurance, in order to be adequately covered.
One common myth in homeowners insurance is that you only need enough hazard insurance to cover your loan amount. In reality, your dwelling coverage amount should reflect how much it’d cost to fully rebuild the home at the current market prices of labor and construction. In some cases, the loan amount may actually be higher than the rebuild cost of the home.
Rebuild costs depend on a number of factors: local construction costs, the age and build of the home, the square footage of the home, your credit score, and so on.
The cost of your policy is determined by far more than simply the hazard portion (your policy also includes personal property coverage, coverage for additional living expenses, and liability coverages). However, hazard insurance variables are an overriding factor in what you’ll pay in monthly or annual insurance premiums. These factors include, but aren’t limited to:
Insurers set rates based on how likely you are to file a claim. Perhaps the biggest indicator of claim frequency is the age of your home, as older homes can be damaged more easily, leading to more claims. Insurers also check to see what kind of security features you have, such as burglar alarms, and often base rates on that as well. Homes with better security systems will generally file fewer claims, leading to lower monthly premiums.
Your policy limit and how high or low your deductible is also affects how much you pay in monthly premiums. A high policy limit and low deductible may mean far higher monthly premiums than you’d like, but these are the cost factors you can customize to your liking.
At Policygenius, we’ll guide you through the homeowners insurance process and help you choose a policy that's both effective and affordable.
About the author
Pat Howard is an Insurance Editor at Policygenius in New York City, specializing in homeowners insurance. He has been featured on Property Casualty 360, MSN, and more. Pat has a B.A. in journalism from Michigan State University.
Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.
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