Imagine you are meeting with your insurance agent to buy a new policy for a home you are about to purchase. As you speak with your agent about how much coverage you’ll need, your agent asks you a series of questions about the size of your property, the type of materials your home is made of, the newness of your property, etc.
Your agent then produces a number: “For complete coverage in the event of a covered disaster,” they say, “You’ll need to insure your home for $400,000.”
You’re bewildered! $400,000!? But you only paid $300,000 for the home in the first place! How could this be?
Market Value Vs. Replacement Cost
This scenario is a common one that you may have encountered yourself or heard of from a fellow homeowner: You’re told to insure your home for far more than you feel it’s worth.
Rest assured. There is a good reason for this.
It all comes down to the difference between market value and replacement cost. A lot of homeowners confuse these two valuations, but there is a significant difference between them.
For starters, market value can be defined as the price you’d sell your home for if you listed it right now, left it on the market for a reasonable time period, and sold it in a fair sale.
Great. That price is probably easy enough to come up with — especially if you’ve just purchased your home in the last few months or year. In this case, you could safely say that the market value of your home was the price that you purchased it for.
If, however, you purchased your home several years or decades ago, don’t use the price you paid for it as the market value will have changed. To obtain an up-to-date market value in this case, we might recommend getting your home appraised or taking a look at the recent sale prices of other similar properties in your neighborhood.
Regardless of how you come up with a fair market value, it will most likely not be enough coverage to rebuild you home in the case of a total loss. To ensure you have enough coverage to replace your home, you should insure your home for replacement cost.
Replacement cost is a term that represents the value of your home being replaced. Let’s look at an example scenario to help explain this concept:
Let’s say your home was recently devastated in a tornado/windstorm (a covered event on your homeowner’s insurance policy). It was destroyed completely.
You had purchased your home ten years ago for $200,000, and (correctly, you thought at the time), you insured your home for the same price of $200,000.
Now, your home is completely gone, and your goal is to replace it with the $200,000 payout from your insurance claim.
Here, you’re going to run into some trouble — primarily because it costs more to replace a home than it does to buy a home that has already been built.
Herein lies the reason why you should never insure your home for its market value.
Instead, you must calculate the replacement cost and insure it for that amount.
How Do You Calculate the Replacement Cost of a Home?
You would think that calculating the replacement cost of a home takes a lot of work. That is not necessarily the case. To do this Insurance agents have a tool called a replacement cost calculator. By entering the number of rooms, square feet, location, and things such as quality of cabinets, etc. They can calculate a replacement cost figure that is surprisingly accurate.
Beyond that, you’ll also need to consider mortgage requirements, and possible endorsements (such as the Extended Replacement Cost Endorsement or the Guard Endorsement).
How do you do all this?
That’s your insurance agent’s job as well.
At Integrity Insurance Agency, our agents are here to assist you in calculating the ideal homeowners insurance amount for your full and comprehensive coverage. Stop by any one of our locations in Topeka, or Burlington to speak with an agent today!