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Homeowner’s Insurance: Replacement Cost vs. Market Value

Now that you’ve bought a new home, there are decisions you’ll need to make about the kind of homeowner’s insurance coverage you want to buy. Deciding on the value that you’re going to insure is the most important choice you’ll have to make. The options you have to weigh for this decision are replacement cost vs. market value. In order to make the most responsible choice to protect your family and your home, you need to know exactly what each of the options entail.

What is Replacement Cost Coverage?

Replacement cost is the amount that it would cost to repair or replace your whole home. In the event that there was damage so severe that your house needed to be demolished and completely rebuilt, replacement cost coverage would reimburse you for the total cost. This amount is based on the size and structure of the home, and whatever was lost or damaged (from the structure of the home itself, not its contents).

Determining the replacement cost of your home is most accurately done by hiring a building contractor to assess your home and provide you with a detailed estimate of his findings. It’s important to note that in replacement cost coverage, the value of the land that your home is on is not included in the amount of your insurance policy. The only values that are accounted for in your insurance policy are the cost of the property’s structure and the systems, fixtures, and finishes associated with its structure.

Benefits of Replacement Cost Coverage

If you were to lose your home, your quality of life and your financial standing would be least impacted if your home was insured with replacement cost coverage. This is because you will be reimbursed for the total cost of replacing or repairing your home, so you wouldn’t incur any significant out-of-pocket expenses. The reconstruction of your home wouldn’t need to be put off because you didn’t have the money for the repairs, so you’d be able to get back to your everyday life as soon as possible. Experts recommend that you take out replacement cost coverage for at least 100 percent of your home’s replacement value.

Risks of Replacement Cost Coverage

Due to the fluctuating nature of replacement value, it’s important to annually review your policy to ensure you’re still fully covered. Whenever you do any work on your home to upgrade or improve any of its structural components, you should give your insurer a call to let them know. Making these kinds of changes can increase the value of your home, thereby increasing its estimated replacement cost. It’s also important to regularly update yourself on the current market conditions for your area, because any increases in labor, material, or transportation costs will directly affect the replacement value of your home. Some policies offer inflation clauses that will automatically adjust the coverage amount and premiums you pay when construction costs change. That’s the safest way to ensure you’re always fully covered.

What is Market Value Coverage?

The market value of your home is the amount that it would sell for if you put it on the market today—including the current condition of its structure and the value of the land it’s on. Your home’s market value is different than its replacement cost in that it considers additional factors beside the material and labor costs of repairing or rebuilding your home. These factors include the school district the home falls within, crime statistics of the local area, and the number of similar homes that are available in the area. The market value also considers the value of the land itself.

Benefits of Market Value Coverage

Generally speaking, insuring the market value of a home is usually less than insuring its replacement cost. That’s one of the most appealing benefits to new homeowners. For this reason, insuring your home’s market value may be most practical for your needs. If you live in an older home, the cost of rebuilding its artisanal woodwork or masonry may be incredibly high compared to the amount you paid for the house. This is because today’s market doesn’t use the same materials as were previously used, so it’s more expensive to get those materials, and you need to contract a specialist to do the work because it’s outside the scope of modern general labor. For a home like this, a replacement cost policy would have much higher premiums than a market value policy.

Risks of Market Value Coverage

The biggest risk of market value coverage is simply that you may not have complete coverage on your home. Consider the scenario that you purchase your home for $200,000, but the actual cost to rebuild the home from the ground up is $250,000. If your home is damaged beyond repair, you’ll be out $50,000 if you take out a homeowner’s insurance policy for the home’s market value. This means that should a fire, flood, or other disaster destroys your home, your insurance would only provide $200,000 toward the repair of your home. If your family didn’t have that kind of money to shell out on the spot, you’d have to rebuild a home that was less expensive than the one you had before.