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What is a Home Replacement Cost?

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A blog post from our friends at Leavitt Group

Home replacement cost: What is it and why is it higher than the market value of my home?

If you’ve ever looked at your homeowners insurance policy, you may have noticed that the amount you’re covered for in case of a total loss is higher than the actual market value of your home. You may assume you’re over-insured and are paying for unnecessary coverage. The experts at Mountain America Insurance will assure you this is not the case. Here’s why:

Your home actually has three values:

  • Market value:This is the value a buyer would pay to purchase your home. This value can fluctuate based on the economy and market.

  • Actual cash value: This is literally the current value of the building materials that make up your home—lumber, nails, drywall, roofing, brick, etc. The actual cash value of your home, known as ACV, decreases with time. As your home ages, the value of the physical components of your home depreciates.

  • Replacement cost: This is the estimated cost to rebuild your home from the ground up, including today’s cost of materials and labor, demolition, removal of debris, building permits, architectural drafting and more.

Why is replacement cost higher than market or cash value?
It’s more expensive to reconstruct a home after a fire or total loss than it is to build a new home on a vacant lot or buy an existing home. Building materials, labor and location all contribute to replacement cost.

In addition, the cost of demolition due to a fire or other loss are factored into the equation. On an empty lot, the builder’s crews can work quickly and efficiently without stepping over debris or tearing down partially damaged walls and ceilings. After a loss, the crews must work cautiously while removing damaged materials and preparing the building to receive new materials. This process slows down the construction time and drives up the labor cost. 

How is replacement cost calculated?
Insurance companies use software to calculate replacement costs. Your insurance agent will ask you a variety of questions about your home and complete a questionnaire using the information you provide. A reconstruction cost will be determined based on the home characteristics—size, type of finishing materials used, etc.—taking into account local costs including permits, labor and materials. The calculation uses data from similar homes, losses and reconstruction efforts the insurance company has dealt with in the past.

The cost estimate will not take into consideration your family discount with a general contractor or the ten percent discount you get at Home Depot as those options may not always be available or apply at the time of loss.

What are the consequences of insuring for less than replacement cost?
In order to purchase replacement cost coverage, you must insure your home for a minimum of 80 percent of the cost of replacement as determined by your insurer. This is an industry standard. There are other less costly options, including a cash-value policy. However, if a loss occurs, you won’t receive enough money from the insurance policy to completely rebuild. So, it’s in your best interest to be up front with your insurance agent regarding the features of your home in order to obtain an accurate valuation and secure the right amount of coverage.

Our goal at Mountain America Insurance is to ensure you have the right amount and type of insurance for your unique situation so that you will be properly covered in the event of a loss. Please contact us at 877-276-7882 if you have any questions or to make an appointment.

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