Standard homeowners insurance or dwelling coverage protects your home against covered claims, including damages to the primary structure of your residence and, to some extent, the belongings housed within.
In general, a standard policy also includes liability coverage to protect you from legal repercussions in the event of injury to others or damages to their property while visiting your home.
That legal coverage protects you and those who reside with you, including pets.
Most insurance companies also extend an option called additional living expenses, which, as the name suggests, reimburses you for living expenses if your home is uninhabitable due to a covered claim.
This policy can provide coverage for meals and hotel bills while the house is being repaired or rebuilt.
When shopping for homeowners insurance, the level and type of coverage you opt for will depend on your home’s estimated value, which in turn is determined by your insurance company based on one of two possible valuation methods: replacement cost or market value.
Knowing the difference between both approaches will help you understand your coverage and give you a better idea of what to expect if you ever have to file a claim.
It will also help you determine how much you’ll receive in the event your home is damaged due to a covered claim, such as a fire or windstorm.
If disaster strikes, you’ll want enough homeowners insurance to rebuild the structure of your home, to help replace your belongings, to defray costs if you’re unable to live in your home and to protect your financial assets in the event of liability to others.
—Insurance Information Institute
Replacement cost means that, at the time of a covered loss, the insurance company would pay—up to the policy limit—for what it would cost you to reconstruct your home in like quality and equal utility, at today’s prices.
That does not account for the cost of the plot of land on which the house is built or what you still owe on your mortgage.
Replacing your home might cost more than its current market value. That’s why most agents will tell you that full replacement cost coverages could yield better benefits for homeowners.
The more comprehensive the policy, however, the higher the monthly premium (full replacement cost coverage can be up to 10% more expensive).
The replacement cost of your home will depend on its age and condition or whether or not it’s up to code.
These types of coverages are ideal for older homes with outdated plumbing or electrical systems, custom features, and other amenities deemed hard to replace or replicate.
Market value, on the other hand, is the amount a prospective buyer would pay for your home in the current housing market if it were being sold in its present condition.
This type of coverage is similar to replacement cost, yet factors in depreciation.
If you have a mortgage, your bank or lender may require you to have a homeowners insurance policy that covers a percentage of your home’s current market value.
This type of coverage may be sufficient for those who own newer homes or live in lower-risk areas, yet a market value policy may not provide sufficient coverage in the event of a total loss.
Replacement Cost vs. Actual Cash Value
Again, since the cost to rebuild a house is often much higher than its market value, most insurance agents will encourage you to purchase an actual cash value policy if you have the means to do so.
You should also be aware of the fact that personal property coverage, that which insures your belongings against theft or damage, is also based on a percentage of your dwelling coverage, typically 50-70% of the coverage selected for the primary structure of your home.
That means the amount your insurance company will pay you to replace personal items will also depend on the level of coverage you’ve selected for your dwelling.
For those who can afford higher premiums, a full replacement cost coverage could yield significant benefits, especially if they own an older home, one with custom-built features, or located in an area considered “high risk” due to the possibility of fires, theft, vandalism, etc.
Nonetheless, a good general rule is to insure your home for at least 80% of its current replacement cost.
Meaning that if the cost to rebuild your home is estimated to be $250,000, your coverage should provide you with at least $200,000.
That would still leave you with $50k in out-of-pocket expenses in the event your home is completely destroyed.
Calculating Your Home’s Actual Cash Value
Actual cash value policies take into account the current market value of the home, which factors in depreciation as well as the size of the lot on which the primary structure is built.
Variables That Determine Your Home’s Actual Cash Value:
Your home’s interior characteristics—including the size and number of bedrooms and bathrooms, the condition of the appliances and major systems, the type of heating, and the fixtures and finishes in the kitchen, basement, bathrooms, and attics—play a significant role in determining its market value.
Similarly, the home’s exterior, meaning it’s architectural style, curb appeal, construction quality, and the size of its lot, are also relevant factors that significantly impact how attractive prospective buyers find your home.
Nevertheless, the main determining factor influencing your home’s market value (and potential future increase in market value) is its location, as well as the number and price range of similar houses being sold in the neighborhood.
Homes in areas with excellent school systems, near public transport, parks, and other attractions will be pricier than those in remote locations prone to fires, near main arteries or roadways, or a sector that’s considered “dangerous.”
Calculating Your Home’s Replacement Cost
Determining how much it would cost to rebuild your home from the ground up may be easier said than done.
The calculation would first and foremost have to take into account the current cost of building materials, hiring a contractor, removing debris from your residence, and myriad other factors.
One thing it does not account for, however, is the size of your lot or any other structures built on your property.
Insurance companies determine a home’s full replacement cost by means of public data and market research on properties in your area.
For the calculations, the company may use their own algorithms and software, making their underwriting guidelines unique.
You can, however, estimate the cost to rebuild your home by looking at construction costs in your area and obtaining estimates for rebuilding a house with the same square footage as your own.
The Insurance Information Institute recommends you call a local real estate agent, builders association or insurance agent to confirm current constructions costs in your area.
Calculate Your Home’s Estimated Full Replacement Cost:
You should review your homeowners insurance policy at least once a year, especially after a renovation, as the market value and replacement cost of your home can fluctuate over time.
Also, remember that while most standard homeowners insurance policies will cover the physical structure of your home at replacement value, many insurers only offer actual cash value coverage for the belongings stored within it.
Check out our article on the different types of homeowners insurance coverages for more information on these coverages and other options.
If you file a claim for the full replacement cost of your home, know that you may receive your payment in two installments.
It’s common practice among insurance companies to send out an initial payment for the home’s actual cash value and then the second payment reimbursing you for your personal property.
Another important aspect to consider when purchasing any type of insurance is inflation.
If you think you’ll be living in your current residence for the foreseeable future, consider purchasing an inflation protection rider to offset the rising costs of construction.
Keep in mind that after major climatic and geological events such as tornadoes and wildfires building materials and construction costs might skyrocket due to increased demand.
If your policy doesn’t account for inflation, your home might be underinsured.*While we make every effort to keep our site updated, please be aware that "timely" information on this page, such as quote estimates, or pertinent details about companies, may only be accurate as of its last edit day. Huntley Wealth & Insurance Services and its representatives do not give legal or tax advice. Please consult your own legal or tax adviser.