Replacement Cost vs. Market Value: What’s the Difference for Home Insurance?

Idyllic Home With Covered Porch

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Replacement cost and market value are two very different things, and it’s important to understand both when you’re a homeowner. The former impacts your home insurance policy, while the latter comes into play when you put your home on the market.

Market Value

Your home’s market value is the amount for which it would sell in the current marketplace in its current condition. Market value fluctuates and can be difficult to predict, but it’s calculated based on your home’s location, internal and external characteristics, and supply and demand.

In most cases, it’s not a good idea to insure your home based on its market value. Your home’s market value might not cover the cost of rebuilding if your house is destroyed by fire or other disaster. Materials and labor may cost more now than when it was built, and special features could be more expensive to replace.

While market value may not be the best metric for insurance, you’ll still need to know the market value of your home if you’re planning on selling it. You should have a professional appraise your home, but you can also look at how much similar houses in your neighborhood are selling for to get a rough idea of your home’s market value.

Replacement Cost

Another figure related to the value of your home is replacement cost. This is how much it would cost to rebuild – or replace – your home if it were completely destroyed.

Why is this figure important? It’s how much you should insure your home for. Replacement cost, or reconstruction cost, coverage insures your home for the cost to repair damage to your home or rebuild it completely at equal quality — at current prices.

Replacement cost calculations can vary depending on the home insurance company you’re working with, but it typically covers plans and permits, labor and materials, and fees and taxes. Land value is not included in replacement value, as it does not factor into the cost to rebuild a structure. Keep in mind that costs for these things at the time of your appraisal will affect your replacement cost value. If supply and demand change, those costs may have increased significantly at the time you actually need them.

Insuring Your Home

In general, you should insure your home based on its replacement cost, not its market value, as the cost of building a home often exceeds its market value. Because it is difficult to predict the future, it’s important to choose a policy to help account for unforeseen circumstances — and to regularly review your home’s current replacement cost in case you need to update your coverage. When choosing a home insurance policy, make sure you research a variety of options and pick the one that is best for you.

Updating Your Policy

Remodeling your home will affect its replacement value, so it’s a good idea to review and update your homeowners’ insurance policy after remodeling. Be aware of fluctuating costs of labor and materials in your area so you can update your replacement cost as necessary. Review your policy annually and update it to reflect any changes in replacement value.

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