How cheap home insurance can actually cost you more

Being frugal is financially responsible, but being a tightwad when it comes to your insurance needs - whether it's health insurance or home insurance - can mean unexpected expenses when emergencies happen.

"Everyone wants to save money," says Loretta Worters, vice president of communications for the Insurance Information Institute (III). "Being 'thrifty' is a good thing…unless it affects you financially."

So, unless you want to risk your home's well being, read on for four reasons why it's a bad idea to buy cheap home insurance.

Your Home Might Not be Protected from Natural Disasters

Catastrophe-related claims accounted for 25 percent of claims costs across the United States during the period from 1997 to 2003, but increased to 39 percent of claims costs from 2003 through 2011, according to a study from the Insurance Research Council (IRC).

As catastrophe-related claims continue to increase, it's imperative to understand what type of insurance you need to be adequately covered.

And while standard home insurance policies typically cover damage caused by fire and windstorms, the III notes that floods, earthquakes, and maintenance damage caused by termites or other pests are some of the disasters generally not part of a standard home insurance policy. However, homeowners can pay extra to add this coverage.

And if you're trying to save some money by avoiding this additional coverage, consider this: If a natural disaster, like an earthquake, strikes your home, would you be able to pay for the expenses yourself?

If the answer is "no," don't be cheap and pay for the additional coverage.

[Is your home properly insured? Click to shop rates and update your policy now.]

Rebuilding Costs Can Be Higher than Market Value

Many homeowners make the common mistake of limiting home insurance coverage to the real estate market value, opposed to the cost of rebuilding the home.

What's the problem with this?

"Market value is used to determine the selling price of the home, while rebuilding costs determine the amount of property insurance required for full protection and peace of mind," says Worters.

She cautions that not having adequate insurance coverage can cost homeowners far more than expected if they have to file a claim, as there is no correlation between a home's real estate market value and the amount of insurance needed.

In fact, "The cost to rebuild a home can greatly exceed its real estate value," adds Worters.

Some homeowners try to save money by reducing their coverage to match sinking real estate values, and are shocked when they discover the amount of work and money required to repair their damaged property.

[Think it's time to update your home insurance policy? Click to compare rates and polices now.]

You May Have Limited Coverage on Liability Protection

Another method of cutting insurance premium costs involves selecting a lower liability coverage amount, but this can be an expensive budget cut. That's because liability coverage protects you in the event that you're at fault for injuries and damage to other people and their property.

"Sure, you can save money on your homeowner's policy by reducing the amount of liability coverage," Worters agrees. "But in today's litigious society, doing so can put you in harm's way financially."

If you are found legally liable for damages and your homeowner's insurance policy doesn't include enough liability coverage, you may have to pay some (or all) of the damages from your own pocket.

So how much is enough liability protection? According to the III, liability limits typically start at about $100,000, but experts suggest purchasing at least $300,000 worth of protection - just to be safe.

Your Personal Belongings May Not Be Covered

Some homeowners try to save money on personal possession insurance by opting for actual cash value coverage instead of replacement cost coverage.

According to Worters, actual cash value coverage (which is generally less expensive than replacement cost coverage) pays to replace your home or possessions, minus a deduction for depreciation. This means that your insurance will cover the cost of replacing an item based on its reduced value due to use and age.

A smarter alternative is replacement cost coverage, which pays for the cost of replacing your home or possessions without a deduction for depreciation (up to the limit of your policy).

While choosing actual cash value coverage can save homeowners money up front, you may end up spending more money to replace your possessions if you have to make a claim.

"The cheapskate will opt for the actual cash value, which saves you about 10 percent a year," Worters says "But in the end, if you have a fire or other disaster, you are not saving at all."