Why you should insure your home at replacement value rather than market value

While preparing quotes for home insurance, we often hear our customers say, “Should I insure my home at replacement value?”

Even though many homeowners have seen the market value of their homes decline as a result of the economic downturn, that does not necessarily mean that the cost to replace a home has similarly declined. Though it might sound nonsensical at first, replacing an existing home from scratch could actually end up costing more (even much more) than the market value of an existing home. This is because the cost of replacing a home has little to do with the market value of the previous structure – materials, labor and other expenses needed to replace a structure simply cost what they cost.

The definition of home replacement cost coverage states simply that “Replacement cost is the amount of money it would take to repair, replace or rebuild your home with materials similar to the kind and quality used in constructing your home”.

An important piece to replacement cost is something called the 80/20 rule. What this means is that your home must be insured to at least 80% of the determined replacement cost for your home in order for you to be fully covered. If you fail to insure your home for at least 80% of the replacement cost, your insurer will not cover the entire cost to rebuild the home and will even assess a penalty on partial loss claims.

Let’s take a hypothetical example. A homeowner owned a 50-year-old home in a coastal area that was completely destroyed by a hurricane. The day before the hurricane, the house had a market value of $200,000 (down from $400,000 before the housing crisis). The homeowner decides to rebuild his home from the ground up, and finds out that the cost to do so will be $300,000, or $100,000 more than the most recent market value of his destroyed house.

Unfortunately, the homeowner had insured the home at $200,000 (which is less than 80% of the projected replacement cost) so now he is now out of pocket for the additional $100,000 to build a new home.  Had the owner carried coverage of at least $240,000 coverage (80% of $300,000) his insurance company would have paid the entire $300,000 replacement cost.  Similarly, if the homeowner suffers a partial loss of $24,000, the insurance company would only cover $16,000 (the loss amount multiplied by the coverage level divided by the replacement cost, which in this case is $24,000 * $200,000/$300,000).

Thankfully, good home insurance agents understand that this situation is anything from hypothetical and that it could adversely affect homeowners if they do not have the correct amount of coverage for replacing a home. With that in mind, how exactly do home insurance companies determine what the proper home replacement coverage should be?

Home insurance companies determine anticipated home replacement costs based on many factors, including both post-damage and actual rebuilding costs. For example, before even starting to rebuild a home, the demolition and removal of debris, trees, and any other materials must occur. In largely affected areas, this debris might have to be transported great distances, which could significantly add to the removal cost. Also, in general, rebuilding sites are less accessible than vacant lots, and there may be costs associated with road access and off-site storage of materials and equipment.

Once building starts, materials need to be purchased, and all of the skilled labor necessary to build a home, including electricians, carpenters, plumbers, painters and roofers need to be hired. Permits, liability insurance and workers’ compensation insurance for these laborers are also included in home insurance companies’ cost estimates. Many other likely and potential costs are also factored into home insurance companies’ home replacement cost estimates, but at this point you should be getting the picture: the bottom line is that market value does not necessarily represent the cost to rebuild a home, and may in fact be way off the actual mark.

So when you are shopping around for home insurance, make sure that you properly address the issue of home replacement coverage, regardless of the current market value of your existing home.



  1. Randy Chorvack on September 6, 2019 at 12:52 pm

    I agree that the cost to replace your home doesn’t go down with its market value. The home stays the same, it just gets a little older. Replacing a low-value wall is going to be just as much as replacing the same wall if it had a higher value. It’s important to remember that when you’re going to get homeowners insurance.

  2. Steve on October 6, 2016 at 10:14 am

    I agree with Sharon & don’t see any answer to her question. Why pay these enormous homeowners insurance premiums (Oklahoma) if the home could be locally replaced with another home in the same price range? It makes even more sense for people who only carry 80% of the insured total replacement cost. The option of having the insurance paid directly to the homeowner for removal of the destroyed home by a contractor could then be paid by the homeowner. The homeowner is then free to replace their destroyed home with one in the same price range and in the same city/state near family if they wanted. For people like me who still have a mortgage, I’m pretty confident that once the insurance company paid my claim, the mortgage company would help obtain financing for the replacement home.

  3. Nathan on October 5, 2016 at 9:42 am

    I’m with Sharon. Leave it up to the homeowner. Come up with a product that puts a cap on replacement cost. Example…. I buy a huge house for 100,000, the replacement cost is 600,000, why can’t I get a product that covers replacement costs for partial loss up to what I’m comfortable with, say 200,000.00, after that, the insurance company pays for replacing that asset, then I can sell the house in as is condition. No way would an insurance company pay for replacement value on a 82 camero, then once wrecked pay for a 2016 camero.

  4. Wnm on April 12, 2016 at 11:04 pm

    I get the general idea, but if you think about it, it doesn’t make sense. The reason is supposedly to rebuild the house as before. How is the insurance company going to do that on an older home? They would have no idea what types of stain glass, wood etc was there. In addition, I had a roof claim, it Was Not repaired up to the par of materials on the decking as original! sounds like BS to me.

  5. Dejan on February 23, 2016 at 5:48 am

    Great article, thank you for this info

  6. Sharon on November 22, 2015 at 3:04 pm

    If my 75,000.00 home burned to the ground, I would not replace it. I would take the money and purchased another home of equal value. Why would I have to pay for a ridiculous replacement cost. Shouldn’t this be my choice and not that of an insurance company?

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