Replacement Cost Insurance Explained

[Cameron Moore]

Many times I have to address the difference between Replacement Cost and Market Value to my clients. Unfortunately, there is a disconnect between Mortgage Underwriters and the actual distinction between the two. 

The main difference is that Market Value includes the land and Insurance does not. That alone causes a $60-$100k difference in the Loan value and the actual coverage that you should carry on your house. The market is also much more volatile than the material cost to rebuild a property from the ground up after a loss. 

On top of that, unlike liability coverage, you can actually be OVER-INSURED. We call it Phantom coverage because if the replacement cost of your property comes back at $250k, but you want the market value covered at $375k then not only are you ~usually~ paying a higher deductible but you actually don't see a dime over the amount it costs to rebuild. You have wasted your premium over the life of the policy. 

There is inflation protection and an endorsement to add 25-50% of additional replacement cost in order to protect you from unexpected inflation (like that of lumber in the last 2 years) but it hardly effects premium and does not effect the deductibles. Trust your Insurance broker! 

[James Hamling]

Quote from @Bill B.:

Don’t forget. Market value could be $100,000 on a home with a replacement cost over $200k. If you have a home in an Hoa where you must replace the home with basically an identical home you could easily end up either out of pocket or not rebuilding if you have market value insurance. 

If your home is worth $400k but replacing it will cost $500k you're going to have to find a way to walk away from that land without being forced to rebuild the home or come out of pocket $100k. Obviously the land is worth nothing if the only thing that can be built on it is a $400k home that costs $500k to build. MAYBE you could come out of pocket $40-50k to turn it in to a small park and donate it to the HOA, if you're lucky.

Insurance is SUPER cheap, not a great place to skimp. A $400k property costs about $640 year and $600k property about $730. With 300/300 liability. (Put an umbrella on top of that, also super cheap.)

I would say a bigger “gotcha” to watch out for us many insurance companies are putting mold and/or water damage maximums in their policies. I had one company try to slip in a $10k maximum water damage rider. I’ve had 2 claims in 25 years with a dozen properties. BOTH were toilet supply line failures. Both were over $30k. 

Insurance premiums do vary a fair bit based on region. In a hail prone area like MN, expect double if not triple from that $. BUT, it's worth it. I just picked up a property in January, May had massive hail storms, now getting new roof & siding for under $5k, THATS some ROI!

And, always ALWAYS get RCV policy, never ever touch ACV. Not in hail prone market, no way, not worth it.