When you purchase a standard homeowner’s policy, your insurance professional will ask various questions about the home to help them determine the replacement cost or value of your home. Many homeowners are concerned that their home is insured enough to cover the balance of their mortgage and do not understand that in most cases, the mortgage value falls short of the actual replacement cost.
By definition, the replacement cost of your home is the amount of money it would take to rebuild your home if were to become a total loss. Although the value of the lot is typically included in your mortgage amount, it is not included in the insurance replacement cost. Your insurer does not insure your lot or land where your house is located. There are other items that are included in the replacement cost besides, boards, mortar, nails and labor. If your home is burnt to the ground as a result of a kitchen fire, you would be left with a pile of debris that must be dealt with along with the additional expense of hiring an architect to redraw the plans according to code changes that may have taken place.
How is Replacement Cost Calculated?
Your insurance agent will use a replacement cost calculator to determine the replacement cost of your home and unattached structures. This calculator (computer program) allows the agent to enter all of the characteristics or your home and any unattached structures so the program can assign the appropriate values and then calculate an accurate replacement cost. The agent can get this data from various sources:
- The homebuyer or homeowner: Your insurance professional will get as much data from you as possible, but it is not your responsibility to know everything about your home or a home you plan to purchase.
- County records: Typically, every county’s tax assessor has a website where property records are stored. The basic information about the home and a sketch of the outline of your home can be found on the tax assessor’s website.
- Real Estate websites: Sites such as Zillow.com and Trulia.com will have most of the characteristics about your home whether or not it is for sale, but not if your home was recently built.
- Satellite images: Many agents will also view a satellite image of your home to get an idea of the lot size and the proximity to other structures.
Once your insurance professional enters all of the information about your home and any unattached structures, the replacement cost program will calculate the replacement cost of your home and add a percentage for debris removal and architectural services.
What is Market Value?
The market value of your home is based on the amount your home would bring if it were for sale at the time your policy is issued. This amount is generally based on comparative properties in the same area your home is located. In most cases, the market value will never equal the replacement cost of your home.
If you purchased your home in a short sale or through a bank’s foreclosure, it is unlikely that you will pay the full market value. If the home is located in a popular or upscale neighborhood, you will typically pay more than the replacement cost because of the demand for the lot or land.
Insurance carriers do not use market value to insure your home because that value does not represent the cost of rebuilding the home from the ground up. The market value has too many variables for the insurer to determine their risk for an event that may happen in the future. Since the cost of building materials and labor can easily be forecasted, the insurer will have a clearer picture of the risk they are insuring and can establish their rates accordingly.