Market Value vs. Replacement Cost
ASHLEY URBAN
When working with homebuyers, it isn't uncommon for me to hear "we’ll send over the appraisal" or "we’re purchasing the home for 'X' amount.” While it is helpful for your insurance agent to know what you are purchasing your home for, this number is not what actually determines the amount of coverage on your home.
Think of it this way- Your insurance company is not going to buy you a new house. They are going to build you a new house. This is why your homeowner's policy covers you for “replacement cost” as opposed to “market value”. When running quotes, your agent plugs your home specifications into a rebuild cost estimator. Running quotes pulls the estimated cost to rebuild your home to the same specs and quality with consideration for:
Today's building material costs – Yikes!
Cost for debris removal – demolition of your home and removal from premises.
Economy of scale – the cost to rebuild does fluctuate slightly based on the market and even the neighborhood. For example, the cost to rebuild in a newer subdivision is often lower than rebuilding in an established neighborhood.
While some clients don’t like the idea of paying $300,000 of premium on a home, they are purchasing for $200,000, it is also important to remember that real estate markets vary greatly from town to town. For example, you can take the same home, place it in Kansas City, Topeka, and Manhattan, and the market value can fluctuate by tens of thousands, but it would cost relatively the same amount to rebuild. For most communities in Northeast Kansas, the replacement cost tends to be higher than the market value.
That said, there are exceptions to this. For example, your lender will also want to ensure your home is insured for your entire loan amount. This may be higher than your estimated rebuild, and therefore, this will determine your coverage amount.
While this is all a fairly simple concept, it is one of the many things homebuyers must stop and consider on their journey to new home ownership!
