Replacement Value vs. Market Value
Replacement value and market value are not synonymous when it comes to your home and home insurance. In order to place the best protection on your home through a home insurance policy, you need to know the difference.
In any insurance policy, the replacement value is something that an insurance company agrees to pay if you file a claim due to loss or damages. Typically, the replacement value is a percentage of the original cost of the items in your home or your home itself. If your home burns to the ground, the replacement value will be the amount you specified when you signed your policy.
When determining the replacement value, think about what it would cost to completely rebuild your home if it was destroyed in a storm or fire. Think about lumber, labor, other building supplies. You don’t have to do this alone either. When you buy your home, you can ask an appraiser if they can give you a home replacement value estimate that you can then take to your insurance company. Or, if you already own, you can have an insurance agent, builder, or appraiser to come out to give you an estimate. It’s recommended that you insure your home for 100% of the replacement value and then more to cover the contents, so it’s important that you know exactly how much that is!
Market value has nothing to do with replacement value. Instead, it is the amount you pay for a home, the land, and the location—regardless of how much it cost to build. In fact, you could very well pay much more for a home than it would actually cost to rebuild depending on the real estate market.
The reason why homeowners are advised against insuring based on market value is because of how often it ebs and flows. Based on a Zillow report, home values have grown 3.3% over the past year and they predict that values will continue to increase by 2.2% more in the next year. However, if you remember the crash of 2008, market value for homes plunged into a pit that has taken years to climb out of.
How should you insure your home?
We discussed this a bit in a previous post, but when it comes to insuring your home, you should always base the value of your house on the replacement value. While some people do opt to insure their home based on market value, this could come back to haunt you if you need to file a claim and the value of your home dropped from the amount you insured it for. Insuring based on market value can also waste a lot of money if you are paying to insure something that isn’t worth that amount.
Trust us. Aside from slight fluctuation in lumber and building costs, insuring by replacement value won’t ever change drastically. If you insure based on that, you’ll ensure that your home can be replaced without any cost to you (minus your deductible) in the case you need to file a claim.
Should you update your policy?
If you’ve done any remodeling that will affect your replacement value, then you should definitely update your homeowners insurance policy. Make sure to go over exactly what it cost to add on any custom features in your home so that if you need to rebuild, that cost will be covered.
It’s also a good idea to update your policy every couple of years anyways—usually when it’s up for renewal. This way, you’ll know if replacement values have gone up or down and you can alter your premium and coverage accordingly.