How To Choose The Right Homeowner's Insurance Limit For Your House

Homeowner's insurance policies come with multiple limit options that offer varying levels of protection for your home. When purchasing home insurance, make sure you select the right limit option for your house and situation.

The Balance of Your Home Mortgage 

The lowest option is a policy limit that's equal to the outstanding balance on your home mortgage. Should your house be destroyed in a tragedy, this option would reimburse the bank for the outstanding mortgage balance so that you didn't have to worry about repaying the rest of the loan yourself.

If there's an outstanding mortgage on your house, this level of insurance is likely required by the terms set forth in the mortgage documents. Most banks include such a stipulation to ensure that their financial interest in a house is insured. Should you fail to get the stipulated amount of coverage, the bank may purchase it and add the cost to your mortgage payment.

The Purchase Price of Your Home

The next level of coverage is to select a limit that's equal to the purchase price of your home, including both your initial mortgage balance and your down payment.

With this amount of coverage, both your bank's and your personal interests in the home are protected. Should the house be destroyed, you'll receive enough to pay off the outstanding mortgage payment and make a down payment on another home. If you've made substantial progress paying down your mortgage, you'll get to keep a little more of the insurance settlement.

The Fair Market Value of Your Home

Rather than selecting a limit based on how much you paid for your home in the past, another option is to get a limit that's equal to what the house is worth today. The current fair-market value might be close to what you paid, or it could be substantially more if you've been in your house a long time or live in an area where the real estate market is hot.

If there's a substantial difference between what you paid for your house and what it's worth today, this choice provides solid financial protection for what's probably the most valuable asset you own. Unless you're upside down on your mortgage and owe more than the house is worth, it also makes sure both your bank and you would be paid in the event of a claim.

The Cost to Rebuild Your Home

For the most complete protection, select a limit that's equal to what rebuilding your home would cost. This includes the fair market value of the house, plus a surcharge for increased labor and materials rates. Adding on the surcharge coverage guarantees that you can rebuild your home even if costs go up in the aftermath of a major disaster, which they frequently do.