Why are you Insuring my Home for More than it’s Worth?

So your house is old and outdated and market prices are at an all-time low. You’re wondering why you’re insuring your house for more than it’s worth.

There are key things to understand regarding how insurance companies valuate your homeowners insurance premium. But before we get into that, it’s most important to pick apart two distinct concepts that oftentimes get confused.

Insuring your home and your home’s value are two different valuations: replacement cost value vs home market value. That’s where we tend to confuse things off the bat, so let’s zoom in a little on these 3 points.

#1 – The market value (appraisal value) of your home is completely different from how much it would cost to rebuild your home in case it was completely damaged.

The value that is determined from a real estate appraisal refers to the market value, or the selling price of your home. This includes several variables including, the overall economy, property values in a particular location, the age and condition of the home, and the type of material inside the home (marble floors vs laminate).

The replacement cost however, is based on the total cost of labor, activities, and materials to put the structure back to the way it was before the damage. This would include costs related to clearing and cleaning up the damage debris -activities that precede the actual build out of the home.

Let’s say an insurance appraiser determined that it will cost $200,000 to rebuild your home. Even though the market value of a home will vary between a small suburb, a major city, and a coastal town, the cost to rebuild your home, had it been in one of those locations, will still be $200,000, or remain relatively the same, given the accessibility of standard building materials.

#2 – A homeowners insurance policy is a contract that guarantees a homeowner the financial coverage to help rebuild the damaged home.

For this reason, insurance companies will base the cost of your premium on the replacement cost of your home, assuming the worst case scenario. Moreover, companies require that your insurance covers at least 80% of the replacement cost of your home in order for them to fully cover your replacement costs.

Let’s say your home replacement cost is $100,000. You decide on a premium that covers up to $80,000. In this case, if a covered peril destroys your house, your insurance will cover the entire amount it will cost to rebuild your house.

#3 – The insurance company (NOT your insurance agent) determines the cost of your homeowners insurance.

While agents collect all the necessary information from the homeowner, it is the company who determines that cost of your premium. Different companies will have different valuation methods, but your agent will be the expert on helping you choose which insurance option to choose based on your situation.

With home market values plummeting in recent years, it’s not uncommon to see replacement costs higher than the value of the property. This is what confuses most homeowners. But it can also work the other way. If you have an old home which you bought at $100,000 30 years ago, it could carry a higher market value today at $250,000. It’s possible for your replacement cost to be more or less than today’s market value, or more or less than the original purchase price.

The important thing to know is that you are insuring your home based on the cost it would rebuild the structure of your house, independent of the market price, your mortgage, or property values.

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