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No homeowner wants to repair or replace their home. Unfortunately, property damage was responsible for nearly 98% of home insurance claims in 2020, according to data from Verisk’s Insurance Services Office.
But if you have home insurance that provides replacement cost coverage, you may not have to pay for any of the rebuilding costs out of pocket, beyond your deductible.
Replacement cost coverage pays to repair or replace damages to your property at today’s labor and construction prices without deducting for depreciation. Market value — which is often confused with replacement cost — is based on the value of the property at its current condition and considers factors like the price of your land and depreciation.
Here’s what you need to know about home insurance replacement cost vs. market value:
- Replacement cost vs. market value
- Calculating the replacement cost of your home
- When is replacement cost lower than market value?
- When is replacement cost higher than market value?
- Should I insure my home at its full replacement cost?
- Can I insure my home at market value?
- Other levels of coverage to consider
Replacement cost vs. market value
When it comes to replacement cost versus market value, understand that these amounts can change over time.
For instance, supply chain shortages could cause the cost of building materials to increase, thereby raising the replacement cost of your home. Similarly, real estate market trends in your area might cause the market value of your home to increase or decrease from one year to the next.
Most homeowners policies include replacement cost coverage for your dwelling, but the limit you choose when you purchase your policy will impact how much you receive from your insurer. Some homeowners don’t discover that they’re underinsured or overinsured until they submit a claim. For peace of mind, you should consider insuring your home at its full replacement cost.
Let’s look at a few elements that can impact replacement cost:
| Impacts Replacement Cost | Impacts Market Value | |
|---|---|---|
| Quality of materials to rebuild | ✓ | |
| Comparable homes nearby | ✓ | |
| Local price of labor | ✓ | |
| Home style/aesthetics | ✓ | ✓ |
| Demolition costs | ✓ | |
| Zoning expenses | ✓ | |
| Local labor costs | ✓ | |
| Home’s age/square footage | ✓ | ✓ |
Credible makes finding a great insurance policy easy. You can compare custom fit options to find home coverage that best suits your needs.
Calculating the replacement cost of your home
Even though insurance agents will likely help you determine the replacement cost of your home, it’s still important to try and calculate it yourself before choosing your policy.
One way to calculate the cost is to hire a professional appraiser or contractor. This should give you the most accurate estimate.
For a more casual approach, you can do the math yourself. You’ll need to factor in material costs associated with a new roof, flooring, siding, and drywall, among other things. You’ll also need to assess local costs for labor, and estimate what the total cost per square foot of replacing your home would be based on those estimates.
Learn More: Types of Homeowners Insurance (Policy Forms)
When is replacement cost lower than market value?
Replacement cost is often lower than the market value of the home because the value of homes and land typically increase at a greater rate than the costs of labor and building materials.
For example, a home purchased 30 years ago will likely have a higher market value than replacement cost because home values have increased steadily. While factors like the pandemic may have driven up the cost of materials for the same home exponentially, it’s likely that the replacement cost is still lower than the market value.
When is replacement cost higher than market value?
A home’s replacement cost can actually be higher than its market value under some special circumstances. For instance, if demand for your home is low and real estate prices in your area are on the low end — perhaps because it’s located in a rural or less-desirable area — then the replacement cost may be much higher.
Should I insure my home at its full replacement cost?
You should consider insuring your home at its full replacement cost, especially if it’s an older home. Older homes may be constructed with materials or methods that aren’t commonplace anymore, which means their cost to insure can be much higher than contemporary materials and methods.
But even if you have a brand-new home built with common materials, you’ll still want to purchase enough home insurance to cover 100% of the home’s replacement cost. Otherwise, you could be responsible for significant repair costs should a disaster strike.
Does the replacement cost amount affect your insurance premium?
Yes, the replacement cost amount will affect your insurance premiums because of the scope of the coverage. The more it costs to rebuild your home, the more insurance you’ll have to pay. When you submit a claim, your insurance company pays the cost to replace the property without taking depreciation into account.
As a result, you’ll typically pay a higher premium for a policy with replacement cost coverage than one with actual cash value (ACV) coverage, which does take depreciation into account.
Find Out: What Does Homeowners Insurance Cover?
Benefits of insuring your home at replacement cost
- You don’t have to worry about market changes. Even if your home’s value decreases, you’ll still be able to fully replace or repair your home.
- It’s a reliable option for most homeowners. Considering the potential financial impact required to return your home to “normal,” replacement cost is a beneficial option for nearly every homeowner.
Drawbacks of insuring your home at replacement cost
- Costs can change. Over time, replacement costs could increase and leave you without adequate coverage. For instance, if you renovate your home without modifying your coverage, you may not get full replacement costs returned when filing a claim.
- Market changes can work in your favor. Depending on your area, decades of development surrounding your home could increase its market value exponentially more than the cost to rebuild it.
Can I insure my home at market value?
You have the option to insure your home at market value, however, it’s not always the best coverage option.
Factors that influence replacement cost, such as the cost of building materials, may have a general impact on homes regardless of location. However, factors like crime statistics and school zoning can have a more acute and lasting impact on home values in a designated area.
Benefits of insuring your home at market value
- Increased home value in a short period of time: If your home is located in an area that’s quickly growing, your home and land’s value may exceed the cost to replace the home.
- Potential savings: If you live in a home constructed with materials that aren’t commonly used in construction anymore, a market value policy could save you money over the replacement cost. For example, if your home is damaged in a flood, you may be required to spend more money on replacement costs to meet any new building code or zoning requirements set by your community.
Drawbacks of insuring your home at market value
- May not have enough coverage: Market value insurance could put you at risk for having less coverage than you need to repair or replace your home. If your insurer is not automatically increasing your coverage (and likely your premiums) to compensate for the increase in rebuilding costs, you may not have the coverage needed for a full replacement.
- Risk of overpaying: You may overpay for your home over the years if you purchase it during a housing boom and continue to own it during a recession. For example, if your home costs $200,000 to replace, it may be valued at $250,000 during a high-demand market. This increases your premiums. However, if a recession hits and your home value drops back to $200,000, you’ll have paid higher premiums for no gain.
Other levels of coverage to consider
Replacement cost and market value aren’t the only options you have when it comes to insuring your home. You may also consider these forms of coverage:
- Extended replacement cost: Extended replacement cost, also known as extended dwelling coverage, can increase your dwelling coverage by 25% to 50%. This can help cover higher rebuilding costs due to a surge in demand.
- Guaranteed replacement cost: This is the highest — and most expensive — level of coverage. It insures you for 100% of repairs and replacement costs.
- Actual cash value: Unlike replacement cost, ACV takes depreciation into account when assessing your home’s value. While this can result in lower premiums for coverage, it also means that if your home or other personal property is damaged or destroyed, you’ll need to cover a portion of the repair or replacement costs out of your own pocket.
Let’s take a look at a few examples of when it makes sense to choose each coverage level:
| Scenario | Extended replacement cost | Guaranteed replacement cost | Actual cash value |
|---|---|---|---|
| You need the least-expensive coverage available. | ✓ | ||
| You’re worried that certain replacement costs may not be covered under a standard replacement cost insurance policy. | ✓ | ✓ | |
| You can afford higher insurance payments. | ✓ | ✓ | |
| Your home has a custom feature that requires extra protection. | ✓ |
Keep Reading: Homeowners Insurance Deductible: What You Need to Know
Stephanie Colestock contributed to the reporting for this article.
