When home market values drop, it’s not uncommon for us agents to get concerned homeowners who ask why their house is being insured for more than it’s worth.
“It doesn’t make sense that my 20-year old home should be insured for $300,000.”
Well the fact of the matter is that most homeowners will miss the difference between the Replacement Cost and the Market Value of the home. They are two very different considerations. Let’s take a closer look.
Market Value of your home
The market value of your home is the value that is determined by a real estate appraisal that has everything to do with the overall economy, the property values in your location, the condition of your home, the type of materials used in your home, and how much it’s worth in the market. It has nothing to do with how much it would cost to rebuild the home in case of some damage.
The replacement cost is appraised by someone associated with the insurance company which accounts for the cost of replacing or rebuilding the entire damaged house. Meaning the total cost of labor, activities, and materials to put the structure back to the way it was before the damage. This would include costs related to clearing and cleaning up the damage -activities that come before actually rebuilding the structure.
Let’s say it will cost $200,000 to rebuild your home. Even though your home’s market value will vary between locations, the cost to rebuild your home will still be $200,000 or remain relatively the same, given the accessibility of standard building materials. So it’s not so much the market value that drives the cost to rebuild your home, but the materials and labor.
Remember that Insurance is a Contract
A homeowners insurance policy is a financial guarantee to a homeowner to help rebuild the damaged home for covered perils.
For this reason, insurance companies will base the cost of your insurance premium on the replacement cost of your home, and not the market value. Oftentimes, insurance companies require that your insurance covers at least 80% of the replacement cost of your home in order for them to fully cover your replacement costs.
So if your home replacement cost is $100,000. You will have to get an $80,000 policy so your insurance will cover the entire cost to rebuild your house.
Remember that the insurance company (NOT your agent) determines your premium
Agents collect all the necessary information from the homeowner, but the company calculates the cost of your premium. Every company will have a different formula for valuating your cost, but your agent will be the expert on helping you choose which insurance option to choose based on your situation.
The important thing to know is that you are insuring your home based on the cost it would rebuild the structure of your house, independent of the market price, your mortgage, or property values.