Insuring an ADU or backyard cottage

An accessory dwelling unit (ADU) is insured differently depending on two facts: whether it is attached to your house or stands apart, and who lives in it. A guest cottage used by family can ride on your homeowners policy as an "other structure." The moment a paying tenant moves in, the standard ISO homeowners form (HO 00 03) stops covering the building, and you need either an endorsement or a separate landlord policy. Tell your insurer before you build, not after the first tenant signs a lease.

The wording below is from the May 2011 edition of the HO-3, hosted by the Maine Bureau of Insurance. ISO revised its homeowners forms in March 2022, and insurers file their own versions, so check your policy and declarations page for the details.

Attached, detached or converted: the starting point

Insurers sort ADUs by how they sit on the lot, because the form treats them differently.

• Attached or interior units (an over-the-garage apartment built into the main roof, a finished basement apartment, an addition with its own entrance) are usually part of the dwelling. Their value belongs in Coverage A, and the rental question becomes a question about the whole policy.
• Detached units (a backyard cottage, a freestanding garage apartment) fall under Coverage B, Other structures coverage (Coverage B): fences, sheds and garages, whose default limit in the HO-3 is 10% of your dwelling limit.
• Converted spaces (a garage turned into living space, a pool house with a kitchen) can be either, and underwriters ask whether the conversion was permitted and finished to residential code.

Ask the agent to tell you, in writing, which coverage the unit sits under. A detached cottage that is quietly absorbed into a 10% Coverage B limit is the classic underinsured ADU.

A detached ADU that nobody pays rent for

If a relative, an adult child or a caregiver lives in the cottage for free, or it is a studio you use yourself, Coverage B generally applies as long as it is not used for business. The HO-3 excludes other structures that are used in whole or in part for business, and those that are rented or held for rental to anyone who is not a tenant of the dwelling, unless the structure is used solely as a private garage. A non-paying family member is not the exclusion's target; whether a relative who pays rent counts as a "tenant of the dwelling" is a wording question to put to your insurer.

The practical issue is the limit. Say your dwelling limit is $400,000, so Coverage B defaults to $40,000 (hypothetical). A detached ADU that costs $180,000 to build today, plus a shed and a fence, will exhaust that limit long before the structure is rebuilt. The fix is a higher Coverage B limit, a separately scheduled structure, or insuring the unit under its own policy. Get the figure from a contractor's bid or the home replacement cost estimator, not from the original permit value, and then ask whether the added limit settles at replacement cost or actual cash value.

Personal property in the cottage is a separate matter. Coverage C covers belongings you own, but the HO-3 excludes property of tenants (with an exception for roomers and boarders related to an insured), and it caps landlord's furnishings, such as appliances and carpeting you supply in each regularly rented apartment, at $2,500 in the 2011 edition. Ask how your insurer treats furniture and appliances you supply.

Once a tenant pays rent

This is the point where most homeowners policies need to change. Three things move at once.

1. The building leaves Coverage B. The rented-to-a-non-tenant exclusion applies to the cottage, so a fire in the ADU is a Coverage B loss only if the insurer has endorsed it back in.
2. Liability changes. A tenant who is hurt on the property, or whose guest is, brings a claim under your personal liability coverage, and the HO-3 liability section has its own business and rental exclusions. See Liability exclusions: what Coverage E won't pay.
3. Your tenant's belongings stay uninsured. Your policy covers your property. A tenant needs their own HO-4 renters policy, and many landlords require it in the lease.

There are two common solutions.

Compare how each one handles lost rent, liability and the main house. landlord insurance: what a rental property policy covers explains the DP-3 and what a rental policy does and does not cover, and Dwelling fire policies: DP-1, DP-2 and DP-3 covers the form family.

Short-term and mixed use

Renting a cottage by the night is a different underwriting question from a 12-month lease. Many homeowners policies exclude or limit short-term rentals, and some insurers will add an endorsement for occasional hosting but not for a dedicated rental unit. A platform's host protection does not replace your own policy; read what the platform's program says about primary coverage and exclusions. For the details, see home-sharing endorsements for occasional hosts and Insuring an Airbnb or other short-term rental. If your ADU may be both a month-to-month rental and a place for relatives to stay, say so, because the insurer prices the most intensive use.

During construction

Building an ADU is a renovation, and the risks are different from an ordinary policy year.

1. Tell your insurer before ground is broken. Some insurers treat a major addition as a reason to re-underwrite, adjust the dwelling limit or require that a licensed builder carry coverage.
2. Ask the contractor for proof of insurance. At a minimum, request a certificate showing general liability and, where your state requires it, workers' compensation. If the contractor's workers are not covered and one is hurt on your property, the claim can land on you; see injured contractors and workers at your home.
3. Ask about a builder's risk policy. The unfinished structure and stored materials may fall outside your homeowners form, particularly if the property is considered vacant or under construction. builder's risk insurance for a home under construction explains the product.
4. Update the limit when the unit is finished. Dwelling and other-structures limits set on the old declarations page do not grow by themselves for a major addition; see insuring a home during a renovation.

Permits, code and the unpermitted unit

An ADU built without a permit creates insurance problems before any claim occurs. An insurer may decline to cover it, may raise the question at inspection, or may argue after a loss that the structure's use misrepresented the risk. Even a permitted unit raises the ordinance or law coverage question: if it is damaged, current code may require upgrades, and the HO-3 pays for that only up to its built-in 10% of the dwelling limit unless you buy more. Read ordinance or law coverage: paying to rebuild to code if your city has changed its building rules since the cottage was built.

Zoning also matters for another reason. Whether a cottage can be rented is a local land-use question, and an insurer may be unwilling to pay a claim connected to an illegal use. If a city says the rental is not allowed, an insurance endorsement does not make it so.

Liability and the umbrella

An ADU adds people, stairs, a second kitchen and often a second driveway to the property. If the unit is rented, consider umbrella insurance for homeowners: what it adds and where it stops, because a tenant's injury claim can exceed the liability limit on a homeowners or dwelling policy. Ask the umbrella insurer what it requires underneath; many want specified primary limits and may exclude certain rental exposures.

Questions for your agent

• Is the unit covered under Coverage A, Coverage B or a separate policy?
• What is the limit, and does it settle at replacement cost?
• Are tenants, relatives who pay, or short-term guests allowed?
• If a tenant moves in, what do I have to report, and when?
• Does the policy cover loss of rent after a covered fire?
• What documents does the insurer want for the permit, the heating system and the electrical work?

Key takeaways

• A detached ADU usually sits under Coverage B, whose default 10% limit is often too small for a new cottage; raise it or insure the unit separately.
• The ISO HO-3 excludes other structures rented to anyone who is not a tenant of the house, so a paying tenant in a backyard cottage typically needs an endorsement or a landlord policy.
• Tenants need their own renters insurance, and short-term rentals need a policy that expressly allows them.
• Tell your insurer before construction, keep the permits, and update limits when the unit is finished.
• Policy wording differs by insurer and state, so confirm in writing how your policy treats the unit.