How to Estimate Your Homeowners Insurance

Many Americans are badly underinsured when it comes to their homeowners insurance. There are a lot of reasons for this. One is that they just don’t know how to calculate what they need. Or they just go with the cheapest, bare-bones coverage. But that’s never a good thing when it comes to home or auto insurance. You need to know how much home insurance you need.

Having the right amount of homeowners insurance is crucial to protecting your home and your finances. After all, your home is your biggest investment. And a lot can go wrong that could potentially devastate your financial goals.

Good news! We’ll show you how insurance companies calculate homeowners’ premiums, as well as how you can come up with your own estimate of how much home insurance you need. (And if you’re just starting to research home insurance, check out our handy Homeowners Insurance Guide.) Even if you flunked math in school (or just didn’t do so well), you can still figure out what you need.

• How Homeowners Insurance Is Calculated
• Factors That Affect Homeowners Insurance Premiums
• How to Perform Your Own Home Insurance Estimate
• Calculating Your Home’s Replacement Cost
• Four Different Types of Replacement Cost Coverage
• Calculating the Replacement Cost of Personal Property
• Calculating Your At-Risk Assets
• Why Is My Homeowners Insurance So Expensive?
• Getting the Right Coverage

You might be wondering, What is the formula to calculate homeowners insurance? And do you have to be a rocket scientist to understand it?

The homeowners insurance secret sauce is complicated. But it’s not impossible to understand.

First, keep in mind that insurance companies are ultimately in the business of making money (duh). No matter how noble their other intentions are, no company can continually lose money and stay in business. This means the price they charge is a balancing act. Charging too much will potentially push customers away. Charging too little could put them out of business.

So, what do they do? Well, in the era of Big Data, they turn to the numbers. When analyzing risk, insurers put policyholders into two buckets: 1) where you live and 2) how risky you are. They look at how likely you are to file claims and how much those claims will cost them.

Here’s generally how insurers figure out what to charge for homeowners insurance premiums. And buckle up! We’re about to do some insurance math.

1. Pure Premium

The pure premium is one of the first numbers insurance companies calculate for groups of homeowners (for instance, homeowners in Los Angeles). One of the factors that goes into the pure premium math is dividing total property losses of the group by total property value. So if the properties were valued at $200 million, and the losses were $10 million, their losses would be 5%, or five cents for every dollar of property value.

2. Expense Ratio

Once they have the pure premium, they find the expense ratio. This is also usually a percentage and includes things like taxes, administrative costs, commissions and how much profit they want to make.

3. Premium Price

Insurers then take the pure premium and the expense ratio, put it in their fancy insurance calculators, and out pops what’s called the gross premium. This is what you end up paying. 

But wait, there’s more . . . 

There are a few other things home insurance companies factor in when calculating premiums.

Replacement Cost

Your replacement cost—how much it would cost to rebuild your house—is a big part of it. (We’ll show you in a second how to calculate your home’s replacement cost.)

Location and Age of Your Home

Another huge factor is where your home is located. If you’re in a flood zone, expect higher premiums. Or if you live in a higher-crime area, you could pay more. And if your home is older, there’s a greater chance it will need repairs. Kinda makes sense . . .

Level of Coverage and Deductible

Your premium is also based on how much coverage you’re choosing, along with what deductible you pick. A higher deductible will mean a lower monthly rate.

Construction Type

This would involve things like what the house is made of (brick, wood, etc.).

Personal Claim History

If you have a long history of filing claims for every little thing, an insurer is going to factor this in. Filing claims on small repairs will only cost you more money in the long run. In fact, it could increase your premium even if your neighbors file a lot of claims. (It might not seem fair, but it’s a factor.)

Your Home’s Square Footage

The larger the home, the more expensive it is to insure.

How Many Live There

If you, your spouse, your children and your entire extended family are all living under the same roof, you’ll pay more in liability because there’s a higher likelihood of incidents.

Protect your home and your budget with the right coverage!

Insurance companies will also take into account things like the type of roof you have, how close you are to things like a fire and police station, if you have dogs (including the breed), your credit score, and what kind of security and fire alarm systems you have.

Now that we saw how insurance companies do their calculations, we’re ready to tackle our own coverage estimates. While we can’t help you estimate your premium since insurance math is a closely guarded secret, we can still help you estimate how much you need. When you’re calculating your homeowners insurance needs, start with these three questions:

1. How much would it cost to totally rebuild my home at current construction costs?
2. How much would it cost to replace my personal belongings?
3. If someone sued me for liability and won, what personal assets would be at risk?

You should also consider if you live in a riskier area of the country. Think about natural disasters like flood damage, earthquakes and hurricane risks. While a standard homeowners policy covers a lot of different events, flooding and hurricanes are just two things they won’t cover. 

The answers to these questions will tell you how much homeowners insurance to get in these three main areas: 1) Dwelling coverage, which protects your house. 2) Personal property insurance, which covers your personal belongings. 3) Liability coverage, which handles legal bills if you’re sued as a result of an accident on your property.

Thankfully, there’s a simple way to calculate your home’s replacement cost. And this number will tell you exactly how much dwelling coverage to get.

Multiply your home’s square footage by the cost to rebuild it. Let’s say your house is 3,000 square feet. Average construction costs in your area are $100 per square foot. So you take 3,000 X $100 and get $300,000. This is the amount of dwelling coverage you should get.

You can find the average construction costs in your area by doing some research online or hiring an appraiser. You can also work with an insurance agent to get this number. And remember that your replacement cost is different from your home’s market value or how much you paid for it. You’re looking for how much it would be to rebuild.

Now that you have your replacement cost pinned down, you have four options to choose from.

Actual Cash Value

An actual cash value (ACV) policy will cover your house and belongings, minus depreciation. So if someone steals your furniture, your insurer will only pay for what your couches were worth when they were stolen—not when you first bought them.

Replacement Cost

Replacement cost coverage is an extra layer of protection since it doesn’t factor in depreciation. It pays to repair/replace your house up to its original value (with some limits). For instance, if you have a $300,000 dwelling coverage limit, and the rebuild costs $350,000, you’ll have to pay $50,000.

Guaranteed Replacement Cost

Guaranteed replacement cost coverage gives you even more coverage but you’ll pay more for the policy. It pays for the full replacement cost of your home and doesn’t factor in depreciation or dwelling coverage limits. So if it costs $350,000, $400,000 or $500,000 to rebuild your home, that’s what the insurer will pay. No ifs, ands or buts about it.

Extended Replacement Cost

A fourth option is extended replacement cost coverage. This will pay for the replacement value of your home (up to the coverage limit) but with an extra percentage of the coverage limit thrown in. It’s more expensive but can come in handy if you live in an area where construction costs are rising quickly (which seems to be nationwide in 2021).

The second calculation is how much it would cost to replace your stuff. The best way to do this is by creating an inventory of everything you own. This might sound hard, but we’ll give you a few tips on how to quickly check this off your list.

Pick a weekend where you’ll have some larger blocks of time (in other words, Thanksgiving is not a good time to bite this off). Then go through your house and garage and write down everything you own and how much it’s worth. Create a spreadsheet where you can total everything up. Also, since depreciation is a factor, estimate how much your stuff is worth now—not what you paid 20 years ago.

Take photos and videos so you have an even more thorough record. And note more expensive items like jewelry or art since there is a limit to what the insurance company will pay. You might need an extra layer of coverage for pricier items. Finally, keep the spreadsheet and documents somewhere that wouldn’t get lost in a house fire.

Most people undervalue their belongings. So creating this inventory is crucial. When you actually add everything up, you might be surprised how much it’s all worth (and how much you still need to organize or get rid of!).

It’s also a good idea to send your insurance company your inventory so they have the proof on file. This will help a lot when it comes time to file a claim. And don’t forget to set a reminder for yourself to update your inventory every year to make sure it’s current.

Now that you know how much your belongings are worth, you can figure out how much coverage to get. Usually your policy limit for personal property replacement is around 50% to 75% of your dwelling coverage. But you can increase this limit if you need to.

The third and final calculation you should make is the total value of your assets that would be at-risk if you lost a lawsuit. This number will determine how much personal liability insurance you should have. If you don’t have personal liability insurance, many of your assets would be “at risk” if you lost a legal battle. These items include:

• Your vehicles (if they’re titled in your name)
• Future wages
• Savings
• Some investments, including real estate
• Personal belongings
• Boats
• Business assets

Depending on where you live, some assets are protected and won’t be subject to a lawsuit. These include things like:

• An IRA
• Annuities
• Benefits from Social Security
• Equity in your home
• An employer-sponsored 401(k)

Create a separate inventory of assets that would be at risk in a lawsuit. Once you have this number, you can find out how much liability insurance you need. You can purchase liability starting from $100,000 all the way up to $1 million. If you need more, you may want to look into getting umbrella insurance for an even stronger defense.

The average cost of homeowners insurance is $1,015 for an annual premium.¹ This is around $85 a month. If you’re paying more, you might be wondering why. And your insurance company isn’t going to tell you. The software and data that each company uses is actually a heavily guarded secret.

That said, there are a couple reasons you could be paying higher premiums. It could be based on where you live, the value of your home or your deductible. (It’s always good to check what homeowners insurance you currently have by looking at your insurance declaration page.)

Insurance pricing changes all the time. One example of this is flood insurance. In 2021, rates are going up for 77% of policyholders due to changes in how they calculate the cost of flood insurance.² The higher premiums are now based on the value of the home, flooding risk and other factors instead of just the elevation of the property.

At the end of the day, insurance is a tricky business and you’re not always going to know why your rate is higher.

Homeowners insurance is complicated. There’s a lot that goes into how it’s all calculated.

If you’re tired of wondering how it all works or how to get the right coverage, we recommend working with one of our top insurance agents who is part of our Endorsed Local Providers (ELP) program. They’re RamseyTrusted and can look at your situation to get you the best quotes at the best price.

When it comes to insuring your biggest investment, the last thing you want is to be playing a guessing game with your coverage. By working with one of our agents, you’ll have peace of mind knowing that your home and belongings will actually be covered if something ever happened.

Connect with a pro in your area today!