When you buy homeowners insurance, just how much should you insure your home for? At Vanyo Insurance, we hear this question frequently from our clients. Many homeowners just assume they should base their coverage off of current sales prices for comparable homes, but the answer isn’t usually quite that simple. First, you should understand the difference between the market value and the true replacement costs of your home.
Replacement Costs Vs. Market Value
Homeowners often assume that they should use the market value of their home as a basis for homeowners insurance coverage. The market value of your home may tell you about how much you’d pay to buy a similar house on a nearby lot. At the same time, it doesn’t tell you how much you would pay to rebuild your damaged home on your own lot. That’s why the replacement cost of a home can vary quite a bit from the market value.
For instance:
- Part of the market value of a home includes the lot. If your home is damaged, you still have the lot, so you can subtract lot value from replacement costs.
- If you own an older home in a modestly priced area, rebuilding costs will generally exceed the price you would pay for another older house.
Depending upon real estate values in your area, your true replacement costs may either be less than or greater than the market value. In areas where property values are very high, rebuilding may cost less than buying high-value property. In areas where homes sell for more modest values, rebuilding costs typically exceed the replacement value. Also remember, the rebuilding costs include construction, labor, and the removal of those parts of your damaged house that cannot be reused in your new home.
What Type of Dwelling Coverage Do You Need?
If you still owe money on your home, your lender may have also included guidelines for minimum dwelling insurance in the mortgage documents. Beyond conforming to your mortgage company’s rules, you can choose between different types of dwelling coverage:
- Guaranteed replacement costs: This kind of coverage will ensure that you can rebuild your home with all of the features and amenities it had before it was damaged. While this is the best kind of dwelling insurance, it’s also the most expensive. You may also add an extra rider to typical policies that guarantee replacement value in case of inflation and unexpected costs.
- Replacement cost: With these policies, you will find the maximum amount of money that the insurer will pay stated inside of your policy documents. This won’t give you the security of a guaranteed replacement cost policy, so you might have to remain flexible about the way your home gets rebuilt or pay the difference out of your own pocket.
- Cash value: Cash value policies will deduct depreciation and wear-and-tear from your settlement. Expect to pay the difference out of your pocket or settle for less than you had before your house was damaged.
How Much Dwelling Coverage Should You Buy?
Average homeowners find it difficult to figure out which kind of policy they should buy and how much coverage to include. You can estimate typical rebuilding costs, but you also have to account for inflation and the possibility of some unexpected costs.
You can speak with an experienced homeowners insurance agent who will help you calculate replacement costs and explain various coverage options. The best answer may depend upon your mortgage company, rebuilding and property value trends, and your own tolerance for risk.
