Insuring Your Home - Replacement Cost Vs. Market Value

Most homeowners have a fairly good idea of what their homes are worth...

So when they glance at their homeowner's insurance declarations, they are sometimes shocked by the fact that the dwelling coverage on their policy is substantially higher than the value of their home. With a big savings in mind, they gleefully ring their agent and inform the agent that there has been some sort of mistake.

But, has there been a mistake? Why is there such a difference between what is itemized on your homeowner’s policy versus what you might see on the county auditor page? There are several factors that contribute to this difference.


Replacement Cost Vs. Market Value

The critical point to understand is that your typical homeowner’s policy is designed to rebuild your home in the event of a partial or total loss. We call the cost associated with rebuilding your home the replacement cost.

Therefore, your homeowner's policy is not necessarily designed to compensate you for the going price. We refer to the "going price" of a home as its market value.

Yes, there are policies that will insure your home for its market value, but it is in your best interest to avoid those policies in most cases.


Things to consider regarding market value and replacement cost:

Location affects market value, but rarely affects replacement cost.

As any real estate agent will tell you, the single biggest factor in determining the market value of your home is location. Again, we're talking about market value here - not replacement cost. A dwelling built in a good school district will have a market value much higher than the same dwelling built on an identical sized lot near a landfill. Yet, these two dwellings would theoretically cost the same amount to rebuild. In other words, they would theoretically have the same replacement cost.

Building materials affect replacement cost.

“They don’t make 'em like they used to!”

It's a saying we’re all familiar with. It rings especially true with home construction. From plaster walls to the quality of lumber, the components used to build homes decades ago vary greatly from homes built today. Many of these materials are hard to find and expensive. Generally, the older your home, the higher your replacement cost will be. This is a very important factor to remember in an area where the average home is 50 years old.

Demolition costs affect replacement cost.

Rebuilding a home is a huge task and many things need to be prepared before rebuilding can even start. Typically, a total loss will leave a good portion of the home still standing. Very often, the remains of the home have to be demolished and all of the debris removed. This potentially hazardous task is very expensive and time-consuming.


Replacing your home... through the eyes of your insurer.

Insurance rebuilds are under different time constraints than new home builds.

Every day that you’re not living in your home, your insurance policy is paying for alternative housing. Insurance companies have a vested interest in rebuilding your home as quickly as possible. By definition, every insurance rebuild is a “rush job”. Insurers may also not have access to the same economies of scale available to developers.


So what's the lesson here?

The dwelling coverage on your home policy is critical. This coverage is most often based on replacement cost, rather than market value. Therefore, it is important that you understand the difference between the two.

Even more importantly, it is absolutely imperative that your agent knows as much about your home construction as possible. Be sure to notify your agent about any upgrades, additions, or remodeling projects that you have completed. Even without any changes, you should review the replacement cost of your home with your agent at least every 5 years.