Insurance Showdown: Replacement Costs vs. Market Value

Insurance showdown: Replacement Costs vs. Market Value

Few homeowners can distinguish a home’s replacement cost from its market value. While one affects your homeowners insurance policy, the other primarily comes into play when you’re putting your house on the market. In case you ever need to rebuild your home from the ground up, here’s everything you should know.

What are replacement costs?

The replacement cost of a home is exactly what it sounds like. It’s how much it will cost to repair or rebuild your house if it’s totally destroyed.

The replacement cost of a home can vary depending on the policy you choose. But generally, you can calculate it by adding up the cost of replacing materials, energy costs, labor costs and fees.

In short, the insurer will take multiple factors and the size of your home into account when estimating its replacement cost at the time the policy is purchased. Over time, this estimate can become outdated and an inaccurate assessment can leave you uninsured. About 60 percent of homeowners face that problem, according to property analytics firm CoreLogic.

Note that insurers will not consider several factors when evaluating a home’s replacement cost, including the value of the land the home sits on and the cost of demolishing what’s left of the property.

In general, it is standard practice to apply the 80% rule. In other words, insurance should cover at least 80% of a property’s replacement cost. If that’s not the case, your policy may not pay for all rebuilding expenses even if the coverage amount exceeds the cost of property damage.

How do I determine the fair market value of my home?

Knowing the current and fair market value of your home is imperative when you’re planning to sell it. A professional appraisal is the best way to determine your home’s fair market value, but it’s also wise to do your own research and speak with real estate professionals.

Agents and brokers often estimate a home’s market value by pulling the prices of similar homes in an area that have sold within the past 30-90 days. The market value of a home also depends on several external factors, such as how close it is to decent schools, shopping centers and public transit.

Think of it this way: Market value depends on supply and demand and what buyers and sellers believe a home is worth. Replacement costs, on the other hand, include the sum of all of the elements that reflect the dollar amount needed to reconstruct a home in the current market.

Real world scenarios: When completely rebuilding a home is necessary

Natural disasters recently devastated several parts of the United States, its territories and countries in the Caribbean. Many families must prepare to replace their entire homes.

Following the wildfires in Northern California, rebuilding homes could take between 12 and 24 months. One expert expects most insurance companies to offer residents reconstructing their homes about $160 per square foot. Other architects say the cost per square foot could range from $300 to $800 for custom homes, based on the current cost of constructing houses in Santa Rosa, California. These costs are rising as reconstruction prices surge.

Bottom line

While knowing your home’s current market value can be helpful, you should disregard it when calculating the cost of rebuilding your home. If disaster strikes, the kind of coverage your insurance company provides will depend on your home’s replacement cost.

Even if you’ve never lost your home to a fire or a hurricane, it’s important to review your homeowners insurance coverage annually. That way, you can ensure your policy accounts for inflation and covers any recent home upgrades.

Need help sorting out your homeowners insurance options? Speak with a Hippo specialist who can address any concerns you may have about how we calculate replacement costs annually. We’re here to help!


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