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When shopping for homeowners insurance, you’ll hear the terms “actual cash value” and “replacement cost.” Actual cash value and replacement cost are both coverage options that determine how your insurer reimburses you for an approved claim.

While both terms refer to an insurance payout, they’re not the same. The coverage option you choose will also affect the cost of your policy.

Here’s what you need to know about actual cash value in homeowners insurance:

What is actual cash value in home insurance?

Actual cash value (ACV) is the amount of money it would take to repair or replace your home or personal property, minus depreciation. The depreciation factors in age and use, so with actual cash value, your insurance carrier considers the cost of replacing your home or property at their current value.

Example: If your sofa is destroyed in a fire, an actual cash value policy would pay you what the sofa is currently worth given its age and condition — not the amount of money you’d need to buy the same sofa brand new.

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How does actual cash value work?

When you file a claim, an insurance adjuster will perform an inspection and determine how much your insurance provider should pay out. To determine the actual cash value of your home or belongings, the adjuster will subtract the depreciation from the replacement cost. The depreciation is how much value an item loses each year.

Example: Let’s assume a windstorm destroys your washer and dryer . You bought the set five years ago for $1,500. The average lifespan of a washer and dryer is about 10 years, meaning the set depreciates by 10% ($150) each year. Over five years, your washer and dryer have a value of $750. In this case, your insurance carrier would pay out $750 to replace the set ($1,500 – $750).

Learn More: Homeowners Insurance Guide: Everything You Need to Know

Actual cash value vs. replacement cost

If you select replacement cost coverage, your insurance provider will reimburse you for the amount to replace your property with a new one of similar value. While you’ll get more coverage this way, you’ll also pay more for it.

Here’s a comparison of actual cash value and replacement cost:

Coverage typePremiumPayoutClaims processBest for
Actual cash valueLess expensiveBased on the cost of replacing items, factoring in depreciationInsurer calculates the current value by subtracting for depreciation — a home inventory and receipts are helpfulHomeowners who want lower premiums and homeowners OK with purchasing older replacement items
Replacement costMore expensivePays the amount to replace the item with a new one at today’s pricesMay receive two payments, one for actual cash value, and another for the difference between ACV and replacement cost once you provide receiptsHomeowners willing to pay a higher premium for more coverage

Actual cash value vs. recoverable depreciation

Recoverable depreciation is the difference between an item’s replacement cost and its actual cash value. If you have replacement cost coverage, your insurer will issue one payment for the actual cash value of your damaged property, minus your deductible. To receive the full replacement cost, you must provide receipts or a signed contract to prove the replacement is complete, and that you need more money to cover it.

Let’s use the same example of the washer and dryer above, with a depreciated value of $750. If you go out and purchase the same (or a very similar) set for $2,000, the recoverable depreciation would pay out the $1,250 difference after you provide your insurer with the receipt.

Check Out: Everything You Need to Know About Home Insurance Claims

Other types of replacement cost coverage

Depending on your insurance carrier, you may be able to choose from a few different replacement cost coverage options.

Here’s a quick look at three other types of replacement cost you can purchase:

Coverage typeWhat it coversCommonly available?Best for
Market value coverageThe total cost of purchasing the home and land in its current conditionYes, but it's not recommendedHomeowners who can cover any gap between market value and the actual cost of rebuilding their home
Extended replacement
cost
Covers an additional 10% to 50% over your replacement cost coverage to account for rising labor/material costsYesBest for homeowners who live in high-risk areas for natural disasters; homeowners who want more peace of mind and can afford to add a rider to their home insurance policy
Guaranteed replacement costCovers the cost of repairs or rebuilding even if the cost exceeds your coverage limitsNo, not all insurance carriers offer a guaranteed replacement cost riderHomeowners who want peace of mind and can afford to pay more for more coverage

When should you insure your home at actual cash value?

Actual cash value policies may be a good option if you want to save money on your homeowners insurance and are comfortable with the risk of receiving less money in the event of a disaster.

An ACV policy may also make sense if you own a newer home that hasn’t had much time to depreciate. Since you can review and make changes to your homeowners insurance policy later, you could adjust to a more comprehensive policy in the future.

If you do opt for an actual cash value home insurance policy, consider adding riders to cover irreplaceable personal items (like expensive heirlooms).


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Disclaimer: All insurance-related services are offered through Young Alfred.

Keep Reading: How to Buy Homeowners Insurance

About the author
Angela Brown
Angela Brown

Angela Brown is a student loan, personal finance, and real estate authority and a contributor to Credible. Her work has appeared in Fox Business, LendingTree, FinanceBuzz, and Yahoo Finance.

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