What is Replacement Cost Anyway?
Do you know how much insurance you should have on your home? Do you know the difference between appraisal cost, assessment cost, market cost, replacement cost, and extended replacement? Odds are the people you count on for this information don't know.
If you asked your mortgage person, realtor, insurance agent, friend, co-worker, or some other person you rely on for financial advice - they would not know the difference between the values.
They probably think they know.
Unfortunately, they probably do not know the difference or how much insurance you should have on your home.
If you think this is an exaggeration - go ask some of people after you read this article.
You will be very surprised.
How can all these people not know? Well, for one they think they already know.
So no one takes the time to learn and because so few know, one would likely receive wrong advice even if they did inquire.
Thus, perpetuating the problem and increasing the likelihood your home is not properly insured.
What happens when a home is not insured to the correct value? The first penalty occurs if you suffer a total loss - a fire or tornado completely destroys your home - you have your home insured for $150,000 as this is the amount you paid for the deal on the foreclosed home.
The cost to rebuild the home is $290,000 leaving you short $140,000.
Now little Jacob and Jessica will need to share a room, everyone shares the one bathroom, no hardwood floors, tile and one less stall on the garage.
The basement can be finished later.
Hopefully, no one notices there isn't any brick on the front of the home as required.
The second penalty for being under insured is when you suffer only a partial loss.
If you insure your home for less than eighty percent of the replacement cost, your claim settlement will be depreciated.
If you only insured it to fifty percent, your settlement will be depreciated accordingly.
Sadly, it probably would have cost very little to insure it to full replacement and would have a real bargain before a the loss.
So, what is replacement cost and how does one determine what it is the correct amount of insurance? Insurance companies determine replacement cost by using an estimating software.
It calculates the cost of lumber, labor, and debris removal based on square footage, construction style - is it custom, basic, etc.
and determines a price.
They then base their rates on those prices.
The land value is not part of the equation.
How much you paid for the home is not part of the equation.
Telling them your out of work brother in law will build it for less will not work and is not part of the equation.
The two common mistakes and misunderstood by mortgage companies are incorrectly assuming loan value equals replacement cost and extended replacement on an insurance policy means it can be insured for less if it has extended replacement.
Generally, the mortgage company wants the home insured to loan value which is not necessarily replacement cost.
It is usually more - except in recent times.
The mistake made by mortgage people regarding the extended replacement part.
They incorrectly assume, for example, if a policy has extended replacement to 125% a $100,000 home need only be insured to $75,000.
Which is incorrect.
Extended replacement is intended to extend beyond replacement cost in cases where, for example, a hurricane hits the east coast and drives up lumber prices due to increased demand and labor prices as many go to help rebuild and causing a shortage of workers in an area.
So, if you want replacement cost, insure your home to replacement cost.
The best way to ensure it is correct is too ask your agent for a copy of the replacement estimate from the company insuring your home.
As if it were not difficult enough - sometimes the values from company to company can vary too.
They do not all use a standard rater and sometimes the rater can be tweaked by insurance companies plus or minus so much.
The good news is most of the time it does not cost much more to insure your home correctly.
Sometimes, if written correctly, all discounts applied and packaged, a good policy with guaranteed replacement can actually cost less.
Hopefully, this has helped you out and saves you some hassle.
If you asked your mortgage person, realtor, insurance agent, friend, co-worker, or some other person you rely on for financial advice - they would not know the difference between the values.
They probably think they know.
Unfortunately, they probably do not know the difference or how much insurance you should have on your home.
If you think this is an exaggeration - go ask some of people after you read this article.
You will be very surprised.
How can all these people not know? Well, for one they think they already know.
So no one takes the time to learn and because so few know, one would likely receive wrong advice even if they did inquire.
Thus, perpetuating the problem and increasing the likelihood your home is not properly insured.
What happens when a home is not insured to the correct value? The first penalty occurs if you suffer a total loss - a fire or tornado completely destroys your home - you have your home insured for $150,000 as this is the amount you paid for the deal on the foreclosed home.
The cost to rebuild the home is $290,000 leaving you short $140,000.
Now little Jacob and Jessica will need to share a room, everyone shares the one bathroom, no hardwood floors, tile and one less stall on the garage.
The basement can be finished later.
Hopefully, no one notices there isn't any brick on the front of the home as required.
The second penalty for being under insured is when you suffer only a partial loss.
If you insure your home for less than eighty percent of the replacement cost, your claim settlement will be depreciated.
If you only insured it to fifty percent, your settlement will be depreciated accordingly.
Sadly, it probably would have cost very little to insure it to full replacement and would have a real bargain before a the loss.
So, what is replacement cost and how does one determine what it is the correct amount of insurance? Insurance companies determine replacement cost by using an estimating software.
It calculates the cost of lumber, labor, and debris removal based on square footage, construction style - is it custom, basic, etc.
and determines a price.
They then base their rates on those prices.
The land value is not part of the equation.
How much you paid for the home is not part of the equation.
Telling them your out of work brother in law will build it for less will not work and is not part of the equation.
The two common mistakes and misunderstood by mortgage companies are incorrectly assuming loan value equals replacement cost and extended replacement on an insurance policy means it can be insured for less if it has extended replacement.
Generally, the mortgage company wants the home insured to loan value which is not necessarily replacement cost.
It is usually more - except in recent times.
The mistake made by mortgage people regarding the extended replacement part.
They incorrectly assume, for example, if a policy has extended replacement to 125% a $100,000 home need only be insured to $75,000.
Which is incorrect.
Extended replacement is intended to extend beyond replacement cost in cases where, for example, a hurricane hits the east coast and drives up lumber prices due to increased demand and labor prices as many go to help rebuild and causing a shortage of workers in an area.
So, if you want replacement cost, insure your home to replacement cost.
The best way to ensure it is correct is too ask your agent for a copy of the replacement estimate from the company insuring your home.
As if it were not difficult enough - sometimes the values from company to company can vary too.
They do not all use a standard rater and sometimes the rater can be tweaked by insurance companies plus or minus so much.
The good news is most of the time it does not cost much more to insure your home correctly.
Sometimes, if written correctly, all discounts applied and packaged, a good policy with guaranteed replacement can actually cost less.
Hopefully, this has helped you out and saves you some hassle.