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Replacement Cost vs. Market Value and What It Means to You

By Teri Dormer

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After weeks, or sometimes months of searching for the perfect house, settling on a reasonable budget, and finally getting through the mountain of mortgage paperwork, you’re finally ready to pick up the keys to your brand new home.

Except there’s one more important factor you have to make some hard decisions about: your homeowners insurance policy. You quickly find out that while you may have paid $150,000 for your home, the insurance companies want you to insure it for $300,000 or more. Understanding the true value of your home means differentiating between replacement cost and market value, and the difference may not always be clear.

Considering all the work that went into getting your home, and the fact that you probably haven’t even moved in yet, it’s hard to image all of the terrible things that would have you taking out a claim against your homeowners insurance. But just because you don’t want to think about it doesn’t mean you shouldn’t be prepared.
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What Is Market Value?

A common coverage option, market value is the amount of money it would cost a new home buyer to purchase your home and land as it currently sits.

Your home may have a base value of $150,000, but that doesn’t include the total cost of the land where it’s been built, the cost of improving the site where it sits, impact fees following damage, or sales commission for an agent or company to rebuild it.

As you can see, the building materials and labor that go into building a house aren’t the only factors that determine its value, and market value coverage takes external factors into consideration when determining how much to insure your home for. It’s also important to consider the neighborhood, crime statistics, school zones, and location and what value they might bring to your overall home cost.

Verdict: In some cases, market value coverage can make a lot of sense. With older or historic homes, the value of the bricks and mortar may not provide 100 percent coverage in the event of a disaster. But always remember that market value can fluctuate, and there’s a chance that using market value for your homeowners insurance could leave you significantly short-changed.
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What Is Replacement Cost?

Unlike market value, replacement cost provides a more linear approach to your homeowners insurance and premium costs by covering the exact cost of repairing or rebuilding your home to its original condition at the time it was damaged.

Instead of including external factors like location or neighborhood, replacement cost covers your home for exactly as much as it would cost to rebuild it following serious damage. The size, structure, material quality, and placement are all preserved financially with replacement cost, reducing the potential that you’d have to pay for any repairs out of pocket.

While replacement cost may seem like a more straightforward coverage solution, most analysts recommend insure a home for at least 100% of its replacement cost and consider including a clause that covers any potential inflation to construction costs.

Verdict: For many homeowners, replacement cost provides the most comprehensive homeowners insurance policy. As long as you’re regularly updating your insurance company when you make improvements or modifications to your home, you’ll never have to worry about insufficient coverage when you need it most.