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?”

Over the years, we’ve seen homeowners watch the market value of their homes decline after an economic downturn. However, this may not be a reason to panic, as the cost to replace a home may not have similarly declined. Replacing an existing home from ground up could 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.

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 that the replacement cost is used to determine your dwelling coverage amount; called Coverage A within your insurance policy. If your replacement cost, and therefore your dwelling coverage, are not calculated correctly, the result could mean you are underinsured and you might have to pay out of pocket on a large or total loss claims of your home.

Take this hypothetical scenario: A couple owned a 50-year-old home that was completely destroyed by a fire. The day before the fire, the house had a market value of $200,000 (down from $400,000 before an economic downturn), while the replacement cost remained steady at $300,000. The couple decided to rebuild their home from the ground up and learned the cost to do so would be $300,000.

In this hypothetical, if the couple insured their home at the replacement cost of $300,000, they would  be sufficiently covered and could rebuild their house. Unfortunately, if the couple had insured their home at the market value of $200,000, they could be required to pay the additional $100,000 cost to build a new home out of pocket. 

Thankfully, good home insurance agents understand this situation is anything from hypothetical and could adversely affect homeowners if they do not have the correct amount of coverage to replace 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, but not limited to:

  • the demolition and removal of debris, trees and other materials associated with the loss
  • any costs associated with road access and off-site storage of materials and equipment
  • the cost of new building materials
  • the cost of skilled labor required to build a home

Many other likely and potential costs may be factored into home insurance companies’ home replacement cost estimates, but at this point you should be getting the picture by now.

The bottom line is this, market value does not necessarily represent the cost to rebuild a home, and may in fact be way off the actual mark especially depending on which market your home is in.

When you’re ready to shop 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.

7 Comments

  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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