The Difference Between Replacement Cost and Market Value on Your Home Insurance
When you purchase a homeowner’s insurance policy and look at the coverage amounts, you may wonder why they are higher or lower than the price you paid for the home or the value of the home according to the current market.
There is a simple reason for this: the amount of your homeowner’s insurance is typically determined by how much it would cost to replace your home, not how much it would sell for on the market.
A home’s replacement cost is the amount of money it would take to repair or rebuild your home, considering the current prices of construction materials and labor.
For example, in the event your home is destroyed in a fire, your insurer will compensate you for the costs associated with rebuilding your house to the way it was before, using materials of similar type and quality.
Now, the market value of your home is the amount of money your house is worth on the current real estate market.
Market value takes into account your home’s value, as well as the desirability of it’s location, the land it is built on, the school district, and the price at which comparable homes in the area are selling for.
Depending on where you live, the market value of a home can be greater or sometime even less than the amount it would cost to reconstruct the home. So, if you determine the coverage limits for your home based on its current market value, you run the risk of being either over insured and paying too much for coverage or underinsured and not having enough in the event that your home is completely destroyed. But don’t worry, it is not typically up to the customer to figure out how much coverage they have. Most of the big insurance companies have their own estimating tools that can figure out how much it would cost to replace a home based on its address and square footage.
In recent years, the cost of building materials has increased significantly in many parts of the country. To protect against this, some insurance companies offer special endorsements such as Guaranteed Replacement Cost or Extended Replacement Cost. Both are slightly different, but ultimately exist to be sure you have enough coverage if building materials are more than expected.
The most important thing to keep in mind is to work with an independent agent to review your home policy regularly to ensure you have enough coverage when you actually need it.