The most important concept that you should always keep at the forefront of your mind when it comes to home insurance is replacement cost. Replacement cost is always much better than actual cash value when considering the valuation method used to pay a claim for damage to your home. Actual cash value takes into consideration depreciation of your home’s components and you will only be reimbursed by your insurance company at that reduced level. On the other hand, replacement cost will cover you for the amount necessary to actually replace the components at their current cost. As you can see, this is a much better type of coverage and it’s important that you verify your policy provides replacement cost.
An important thing to remember about both replacement cost and actual cash value is that they are not market value, which is what your house would fetch if you sold it. Market value is based on more than just the cost to build your house as it takes into consideration that most key concept of real estate: location, location, location. While the value of your land is a significant component of your home’s market value, you cannot insure your land. Insurance companies tend to see dirt as something that is indestructible and, as a result, cannot be insured.
This doesn’t mean that if there was damage to the foundation of your home or if rebuilding required some movement of dirt that those items would not be covered. It simply means that the market value of your land is not really an insured portion of the replacement cost. Therefore, you need to be careful not to include any of that market value when reporting the replacement cost of your home for insurance purposes. If you do, you will end up paying more insurance premium on a much higher value and not really getting any benefit in the event of a loss.
With all that said, it’s necessary to consider a few things that do take place during an appreciating real estate market that can affect your home insurance. During the last hot market, real estate and construction were among the main drivers of the economy. As such, the demand for labor and materials was significantly heightened. When this demand is increased, your replacement cost will likely also increase as you will find it more difficult or expensive to hire a contractor to rebuild your home. Your contractor may also have to pay more for materials as he will be competing with other contractors building new homes, who are trying to cash in on the demand. This can be made even worse in the event of a natural disaster that creates a huge, temporary surge in demand for labor and materials.
As you can see, the cost to replace your home is not stagnant and you should always keep an eye on overall market conditions. With the current increase in the overall real estate market, you need to separate your replacement cost from your home’s market value.