Before purchasing a home, you are required to purchase homeowner’s insurance as well. But how do you know how much to insure your home for? Most would think that they need to cover only the price they pay for the house. However, that price isn’t enough coverage to pay for your home in the event of a disaster such as a fire or storm. In most cases, your home’s real value is greater than its market value. That is because market value deals only with the buying and selling process, not rebuilding. And rebuilding costs are much more than the costs to build a home from scratch due to costs of demolishing/cleaning up the existing home, not being able to buy in bulk for supplies, and labor for a single rebuild versus multiple.
So which amount of coverage do you go with? Depends on the risks you want to take. Below we will go over the differences between a home’s market value and replacement cost, followed by the best option we recommend for the average homeowner’s insurance policy.
Market value is the price a home can sell for in its current condition. Knowing this price is beneficial when buying or selling a home, but not necessarily for rebuilding. As we said already, there are a number of factors that cause rebuilding the same home to be much more expensive than the home’s market value. Market value is affected by factors such as the location of the home, crime rates in the area, amount of land, proximity to schools, and the availability of similar homes. The most important detail to note about market value is that the price is rarely high enough to cover the cost of rebuilding it since materials and labor costs could be more than when the house was built and one-time jobs are typically more expensive.
Benefits: Occasionally, a home may be worth more on the market than it would take to rebuild such as if the home were historical or consisted of elaborate artisanal work that would be worth a lot of money. If you have a home such as this, you can choose to purchase a historic home policy, but these are often more expensive. To save money, you could insure your home based on the market value in order to recover after a loss.
Risks: If your home’s value isn’t placed in the history or craftsmanship, insuring your home at market value puts you at risk for not being fully covered in the event of damage to the house. You would be required to pay the difference between your home’s rebuilding cost and market value in order to rebuild. The only other alternative would be to build a less expensive home elsewhere.
Replacement cost is the amount of money it would take to rebuild your home after being destroyed. Coverage at this price will insure your home for the cost to repair any damage or even rebuild your home at the current prices. A building contractor can help you estimate the replacement cost of your home based on the property’s structure and associated items as well as costs such as plans and permits for rebuilding, labor, materials, fees, and taxes. Keep in mind that the land value is included in the market value only, not the replacement cost as the land will not have to be rebuilt.
Benefits: You will be able to experience minimal financial interruption should your home be destroyed. If you go with this option, it is best to insure your home for 100% of its estimated replacement cost.
Risks: The cost to rebuild your home can vary over time. There is no guarantee that you will be 100% able to rebuild your home at the estimated replacement cost. To increase your chances of keeping your home fully covered against destruction, we recommend reviewing your policy annually to make sure your amount of coverage is still appropriate for you. Factors that can affect your replacement cost include home upgrades and improvements, market conditions, labor and material costs, and transportation prices. For the maximum amount of protection, you can consider a policy that includes an inflation clause to automatically adjust and account for changes in construction costs.
Unless you believe otherwise based on the benefits and risks listed above, insuring your home for its replacement cost is typically the best and safest option. While, yes, insuring your home for its market value is cheaper now, you will be more adequately covered down the road should anything happen to your home.
Ultimately, when you make your decision, research all your options and please talk to any of us at Langlois Insurance Agency about your situation.
As always, please don’t hesitate to give me a call with any questions or comments — I always love to hear from my customers!