How much homeowners insurance coverage should you have?

Homeowners insurance provides three-pronged coverage. First, it covers damage to your home (the dwelling itself). Second, it provides coverage for your personal property, both on and off the premises. Third, it provides liability protection for damages caused by your negligence. And although your mortgage lender will likely require you to have sufficient homeowners insurance to cover its interest in the property, you may need additional coverage to adequately protect yourself.

Property coverage—your home

To determine the level of property coverage you should have on your home, you'll need to find out how much it would cost to rebuild it, since the cost of rebuilding a home is often higher than the price initially paid for it. An insurance agent can help you calculate the current cost of construction for a home like yours, or you can hire a professional appraiser.

It's important not to mistake market value or taxable value for the amount for which you should insure your home. For example, assume you own a 2,000-square-foot home that has a taxable value of $125,000 and would cost $70 per square foot to rebuild. The total cost to rebuild your home would be $140,000. If you were insured only for your home's taxable value, you'd have a $15,000 deficit.

Property coverage—your personal property

Standard homeowners insurance policies typically cover your personal property at 50 percent of the value of your home. Certain items (e.g., jewelry) are covered up to a specific dollar amount. However, this standard level of coverage may not be sufficient to cover the replacement of your property.

Ideally, you want enough insurance coverage to replace your possessions if they were destroyed or stolen. If the value of your possessions is more than 50 percent of the value of your home, you can buy additional coverage through riders and/or endorsements.

To determine how much personal property coverage you need, start by making an inventory of all of your home's contents. List the serial number, date, and cost of purchase. Be sure to include any receipts, if possible. To make things easier, you may want to use a video camera or take photos.

Liability coverage

The standard amount of liability coverage in a homeowners policy is $100,000, and the policy provides coverage for liability claims, medical payments to third parties, and legal costs for any lawsuits brought against you. The amount of liability coverage you should have depends on the assets you would like to protect (e.g., home, car, investments).

It's important to periodically review your homeowners coverage to make sure that it's in keeping with any major purchases or additions to your home. For convenience, you may want to add an inflation-guard endorsement to your policy, which instructs the insurance company to automatically raise your policy limit (no doubt this will also increase your premium) at each policy renewal, according to a predetermined index of local home values.