November 17, 2014
When you first purchase homeowner’s insurance, you may find that you are paying for a policy with more coverage than your home is currently worth. Is this just a way for the insurance company to extract more money from you? Probably not – your policy may cover replacement value of your home instead of market value. These are very different numbers.
There’s a little more to it, but in essence, replacement value is what it will cost you to build a house at today’s prices, whereas market value is what it would cost you to buy it.
- Replacement Value – This is just as it sounds – it is the amount of money required to replace or rebuild your home, based on the general structure and size of the home prior to the damages. This should include materials and labor, as well as any demolition and removal costs associated with damaged areas.
Since replacement value only refers to the physical replacement of the home, it has nothing to do with the corresponding land on which it sits (or used to sit).
- Market Value – This is the estimated amount a buyer would pay for your home and the associated land. Market value includes factors that have nothing to do with the physical house itself, such as desirability of the location, the number of other houses available in the market, and the general condition of the neighborhood. The exact same house can be relocated several miles away and have dramatically higher (or lower) market value.
Even though land is included in the market value of the home, your actual coverage will subtract the value of the land (since you are not replacing the land).
Full replacement coverage replaces your home at the current prices and is correspondingly expensive. Market value coverage will be less expensive, but is highly unlikely to cover actual replacement value for your home.
Which one should you buy? That depends on what is important to you. How important is it to you that your house be replaced as it was? Would you rather save money on premiums and scale back your replacement home in case of catastrophe?
Regardless of what policy you choose, check the details to make sure that you fully understand the policy, what it covers and what is required to maintain the policy. There are variations and riders available for both types of coverage.
Replacement value changes over time, so you will need to review your coverage periodically and maintain it at a certain minimum level to qualify for full replacement. Replacement value policies are available with inflation clauses that adjust both your coverage and your premium to keep you from falling below the minimum level.
Market values change over time as well – and not always positively, as many homeowners can attest to over during the housing crisis several years ago. It is up to you to adjust your policy accordingly to make sure your coverage is suitable for your current situation. A good insurance agent can help you with periodic reminders about your coverage level.
Note that this discussion only considers your home, not the contents. Coverage for the contents is usually outlined in a separate section of your homeowner’s policy.
We cannot recommend a policy for you; you have to determine what is most important to you and what you can afford. Whatever you decide, just make sure you have investigated the options, understand the coverages, and have purchased and maintained the best homeowner’s policy for your family’s situation.
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