Replacement Cost vs. Market Value
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Replacement Cost vs. Market Value
The primary point of homeowners insurance is to rebuild your home after a disaster. Whether it is fire, wind, or a gas explosion, your insurance offers peace of mind. When you buy home insurance, your property needs coverage to replacement cost value and not the market value of your house.
Let’s break down what they both mean for your home and your insurance.
Homeowners Insurance Replacement Cost
This term refers to the cost of rebuilding your home from scratch. If a tornado swept through tomorrow, you would have to rebuild. Replacement cost does not account for other factors, such as the median price for similar homes and land value. Your home’s RCE also does not include personal property. Instead, that gets paid separately.
Elements that do come into play when choosing coverage amounts include:
- Construction costs (i.e., labor and materials)
- Age of home
- Square Footage
- Custom homes and building elements (i.e., vintage architecture)
Homeowners Insurance Replacement Cost Examples
- Prime Real Estate. Let’s say you found a wood-frame house on Realtor.com for $800,000. You apply for homeowners insurance, and the insurance agent tells you the RCE is $500,000.Do not worry! The selling price for the home includes your 5 acres of waterfront property is a very prestigious area. You only need $500,000 to rebuild the only the house.
- Historical Home. A different example is buying an older historic home. Older homes often come with higher risk factors. They might still have outdated building codes and may be more expensive to rebuild. Let’s say that Zillow lists your home’s market value at $300,000 for your older home, but its RCE is $500,000.The RCE is higher because you must pay a lot to upgrade to current building codes. Plus, you must hire woodcarvers to replace the ornate custom Italian-designed staircase, doors, and wood paneling.
Market Value Homeowners Insurance
Market value homeowners insurance is based on what you could sell the property for at the time of a claim. This value includes elements like land, median home prices, and the neighborhood. Keep in mind that market conditions shift regularly, and you cannot control them.
It is unusual for an insurer to offer market value insurance for a house. Still, you may see it used in a scheduled personal property endorsement or a personal articles floater. These are home insurance add-ons for high-priced items and items like antiques for which market values fluctuate.
If you buy market value homeowners insurance for your home, you leave yourself at risk. If the housing market crashes and your house burns down, market value home insurance only pays you the post-crash amount to rebuild it. If the new low market price is lower than your RCE, you might have to build a smaller house.
Elements that affect a home’s market value include:
- Current Housing Market. Look at the supply and demand of houses in your area. More demand drives up the price of homes.
- Curb Appeal. Elegant landscaping or other outdoor elements can increase a home’s value. The opposite is also true (i.e., faded or cracking exterior paint).
- Number of Rooms. On average, more bedrooms and bathrooms inflate a home’s market value.
- Location. Some neighborhoods are more desirable than others, such as those with low crime rates.
Market Value Homeowners Insurance Example
- As a rule, the real estate market value is often higher than the replacement cost estimate. In some cases, though, the market value may be lower than the replacement cost.For example, you may have bought the house for $200,000, but the RCE is worth $250,000. While you got a great deal on your new house, expect to buy insurance to cover the RCE or $250,000 for dwelling coverage.
- During the late 2000 recession, many homeowners were left underwater. If they lost their house to a disaster during that time, it would have been an even greater tragedy. It is possible that a homeowner then could have paid $400,000 for a new home with an RCE of $350,000.The home’s market value might have dropped to $325,000. In this case, if the homeowner had market value insurance, they would have paid $25,000 out of pocket to rebuild.
Replacement Cost vs. Market Value in Home Insurance: Which is Better?
It depends. Replacement cost is a much safer option; you will always have enough insurance to pay for a total rebuild. Market value is ideal when the value of an item fluctuates; if the property’s value increases, you have the ability to get reimbursed for what you would pay for it on the open market. Yet, if it decreases, you might only get less than its value or the cost to rebuild or replace the item.
When talking with your insurance agent, ask for quotes for both market value insurance and replacement cost insurance. If market value insurance is higher, you may think it is better to extend your coverage to meet it. However, doing so will drive up your insurance premium.
Keep in mind that the RCE estimate can also fluctuate and go up over time. For example, if raw material prices increase, it will inflate rebuilding costs.
Regardless, it is wise to remain diligent and evaluate your home insurance annually.