Knowing how much your home is insured for is vital to guaranteeing that you are insured properly. One of the most common questions we get is regarding how the insurance companies determine the value of the homes they insure. This process is called home valuation. I would like to discuss the difference between Market Value and Replacement Cost Value with you today and how it affects your homeowners insurance.
Market Value for Homes
This is a common scenario for us: A client is looking to purchase home insurance, and one of the first things they say after seeing the quote is, “Why is the coverage so high? I am buying the home for less than that.” We then explain the difference between Market Value and Replacement Cost. Market Value is simply what someone is willing to pay for a home. If a home is listed for $150,000, but other similar homes are listed for $140,000, that person is most likely asking above Market Value for their home. As the housing market changes, the Market Value of a home will follow suit. Market Value also includes the land in the value, but home insurance policies do not cover land. Insurance companies do not use Market Value to value a home.
Replacement Cost Value for Homes
Insurance companies use Replacement Cost Value in order to gauge how much insurance is needed on a home. Replacement Value takes into consideration the cost to build a home and uses the construction information of the home such as materials used, square footage, and number of rooms. These factors are then used to determine construction costs in the zip code of the home being evaluated. The Replacement Cost Value will increase or decrease based on the costs of construction in the area of the home that is being quoted. Insurance companies use Replacement Cost Value as opposed to Market Value because the purpose of homeowners insurance is to replace or repair the home in the event that a covered loss occurs. The insurance companies are looking to rebuild your home if it is destroyed, and in order to do that, they have to make sure that it is covered at the cost of rebuilding the home. That is why insurance companies use Replacement Cost Value to value your home.
While Market Value and Replacement Cost are different, they are related. They use completely different data to determine value, but they do tend to follow the same trends. As Market Value increases, Replacement Cost Value will often increase. When Market Value decreases, the Replacement Cost Value will decrease. The Replacement Cost Value will decrease to a certain point, but construction costs will only go down so far. For example, you could buy homes for less than $50 per square foot in 2009, but it would have been very unlikely to build a brand new home for that price in 2009.
If you are ever concerned that your home insurance is not reflecting the correct value of your home, you can always contact your local agent and ask them to run a Replacement Cost Estimation on the home to see if it is insured properly. If your home is overinsured, changing the coverage to reflect the Replacement Cost Estimation might even save you money!