Understanding the difference between the market value of a house and the replacement value often confuses homeowners when applying for homeowners insurance. Unfortunately, there is a great deal of difference between the two, which can be significantly important if you suffer a loss on your house in a disaster.
What is Market Value?
The market value of a home is what a home would sell for in the current market today. This isn’t necessarily the amount you paid for the home when you purchased it five years ago or even what you think it should be worth today.
However, the important thing to understand is that the market value is not what it would cost you to build an exact copy of your home as it appears today. Therefore, when applying for homeowners insurance, you would never want to buy a homeowners insurance policy (texasquotes.com) based on the market value.
When purchasing a homeowners insurance policy, you want to have enough insurance to cover all the building costs incurred when replacing your home.
What is Replacement Value?
The fact is most of us couldn’t walk out and pay cash for a new replacement home if our home was demolished by an earthquake or hurricane in Texas for example.
However, that’s why we buy homeowners insurance. The intended purpose of insurance is to cover potential losses that homeowners may incur if there should be a devastating loss. Ideally, you want to cover all the costs of rebuilding your home, no more or no less.
When figured correctly, the home replacement value is designed to replace all costs for rebuilding a home when it’s destroyed by a tornado, earthquake, fire or major flood. The cost of home replacement includes the amounts it would cost to repair a home, or rebuild a house with similar materials and the same quality of construction.
Insurance companies can vary somewhat in their homeowners insurance policies, however, a great deal of them use an 80/20 rule when discussing replacement values. Texas is in fact, one of the states that requires that you insure your home for at least 80 percent or more of the cost of rebuilding the home.
How the 80/20 Rule Applies
This example illustrates the importance of accurately determining replacement values and maintaining and updating your homeowners insurance policy. Let’s say you are a homeowner with a beautiful coastal home in Texas when a hurricane totally destroys the home.
The owner didn’t bother to calculate re-construction costs for a replacement home, but he used the current market value of his home at $200,000 for insurance.
After the home was destroyed, replacement costs totaled $300,000, which was not equal to 80 percent of projected replacement costs required for homeowners insurance by the insurance company. It was $100,000 short. The insurance company wouldn’t cover the shortage, and the homeowner is on the hook for the remaining $100,000.
If the owner had just insured the house for the cost of rebuilding at $240,000 or more (80% of $300,000), he would have met the 80 percent rule, and the insurance would have covered all rebuilding costs.
Home Replacement Factors
There are many factors taken into consideration when estimating replacement values for homeowners insurance policies.
· Permit costs.
· The purchase of building materials.
· Workers’ compensation coverage for employee laborers.
· The labor charges associated with the removal of trees, debris, demolition services and debris transportation.
· Costs associated with hiring, general contractors, roofers, painters, plumbers, carpenters and electricians.
An experienced insurance agent should be able to help you develop a realistic replacement value for your homeowners insurance coverage.