I’m paying $574,000 for this house, but it only needs to be insured for $225,000.
Agents often find themselves answering questions like this because consumers can be confused when it comes to the appropriate homeowner’s coverage amount for an insurance policy on a newly purchased home.
Market value (the $574,000 referenced above) is the opinion of what someone is willing to pay for a home. For a single-family home, that price includes the cost of the land the home sits on. But the market value of any home, whether it’s a single-family home or a condo, is affected by many variables that can make one home more or less desirable than a seemingly similar home. A home’s view, school district, proximity to conveniences such as transportation, nuisances such as freeways or airport noise, crime rate and even intangibles such as the reputation or ambience of the neighborhood can dramatically a home’s market value. Two identical homes in the same neighborhood can have vastly different market values simply because one has an ocean-front view or sits next to the 18th green of a beautiful golf course.
However, almost none of these variables affect how much it would cost to rebuild a home in the case of a loss.
Homeowners insurance provides homeowners with a variety of coverage. The dwelling portion of a policy – which is referred to as Coverage A – is intended to cover the expense to rebuild the home on the existing site should the homeowner suffer a loss that completely destroys the home. For this coverage, the policy uses a value called “reconstruction cost” (the $225,000 referenced above), which is the cost to reconstruct the home excluding its contents and the cost of the land. The contents of the home, of the home, such as clothes and furniture, are covered by a separate part of the policy.
Because reconstruction cost considers only how much it costs to rebuild the home on the existing site, two identical homes with vastly different market values can have similar reconstruction costs. Depending on the neighborhood, the condition of the home and the local housing market, the reconstruction cost of a home can be more or less than the market value of the home, which comes as a surprise to many homeowners.
So, how is reconstruction cost calculated? Years ago, underwriters used a simple cost-per-square-foot calculation to estimate the reconstruction cost of a home. However, today’s software tools are more sophisticated and can virtually “build” a home from the ground up using local “real” labor and material costs, current building codes and fees and other unique characteristics of an individual home. These tools provide insurers and homeowners with more accurate and dependable reconstruction costs and, as a result, more accurate insurance coverage.
So the answer to that seemingly simple question “What is my home worth?” can have multiple answers depending on the context.
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