When you purchase a homeowners insurance policy, you’ll make a number of decisions about your coverage. One of the most important is whether to insure your home for its replacement cost or its market value. Understanding each option will help you make an informed choice that safeguards your home and your family’s financial future.
What is replacement cost?
Replacement cost is the cost necessary
to repair or replace your entire home. When you insure your home for its replacement
value, your insurer will reimburse you for the cost of rebuilding or repairing
your home, based on the size and structure of the home that was lost or
damaged.
The most accurate way to determine the
replacement cost of your home is to hire a building contractor or other
building professional to produce a detailed estimate. Only the cost of the
property’s structure and its associated systems, fixtures, and finishes will be
included in the estimate; land value is included in a home’s market value but
should not be included in the amount of insurance you buy.
Benefits
In the event of a loss, replacement cost
coverage will help your family return to their home and usual quality of life
with minimal financial interruption. For the best protection, experts recommend
that you insure your home for at least 100 percent of its replacement cost.
Risks
Replacement value can change over time,
so you should review your policy annually to make sure its coverage meets your
needs. Inform your insurer if you have upgraded or improved your home, because
these alterations may increase your home’s estimated replacement cost. Also,
you’ll want to stay informed about changing market conditions in your area.
Rising labor, materials, and transportation costs can directly affect your
home’s replacement value. For maximum protection, consider a policy that
includes an inflation clause that automatically adjusts coverage and premiums
to account for changes in construction costs.
What is market value?
Market value is the amount that a buyer
would pay to purchase your home and its land in its current condition. Unlike
your home’s replacement value, its market value is influenced by factors beyond
the material and labor costs of repairs or reconstruction, such as proximity to
good schools, local crime statistics, and the availability of similar homes.
Also, the land itself will be included in the home’s market value, although it
will not be covered by the homeowner’s policy.
Benefits
In some cases, market value coverage may
be the most practical option. Take the example of an ornate older home. In
today’s market, the cost of rebuilding or restoring artisanal woodwork,
masonry, and plastering to their original condition may be much higher than the
home’s purchase price. Therefore, the replacement policy premiums for the home
would be high. (Special policies are available for some historic homes, but
these also come at a higher price.) For a cash-strapped homeowner, buying a
policy based on market value offers the best chance to recoup at least partial
expenses after a loss.
Risks
When you insure a typical home for its
market value, you are at risk of having incomplete coverage. For example,
imagine that a family buys a home for $175,000 and takes out a homeowner’s
policy for the same amount. The replacement cost for the home, though, is
$225,000. If a fire or other insured event destroys the house, the insurance
settlement would be $50,000 less than the actual replacement cost of the home.
The family would either have to make up the difference themselves or build a
new, less expensive home.
This article is provided for you from
State Farm Insurance and Tricia Zwirner.
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