Homeowners Insurance: How is the Dwelling Coverage figured?

How is the Dwelling Coverage figured? - Hey, in this article is about replacement cost versus market value as it has to do with insurance. It's a super common thing to be confused about. We're gonna un-confuse you right now when it comes to this topic. Just quick definitions of the two different things and what they are. We'll talk about how replacement cost affects your insurance, and then we'll talk about how market value affects your insurance.

Pretty simple, pretty quick, just gonna lay it out for you. Let's start with some definitions. Replacement cost is the amount of money it would cost to actually rebuild your home. That means hiring contractors, having drywall put in, framing done, roofs put on, kitchen stuff put in, your crawl space built, probably not in that order but you get what I'm saying.

Read also: Homeowners Insurance: How Wind Hail Roof Coverage Works

The actual cost of rebuilding your home. 

So if your home burned down or be knocked over by a tornado or something like that, how much is it going to cost us or cost the insurance company to rebuild your home? That's the replacement cost and that's what replacement cost means. Let's talk about market value.

It's a completely different thing. This is the amount of money your home could sell for in the current retail market. So if you're a first time home buyer right now or you're someone who is buying a home right now, you're looking at purchasing that home for a certain amount of money. That may or may not have any connection with how much it would cost to rebuild that house because the market in your area could be much higher if there's high demand and low supply of homes, then it's going to be more expensive in your area to buy homes.

If there's low demand and high supply of homes then it's gonna be cheaper to buy homes in your area. That side of things, the real estate side of things has nothing to do with what it would actually cost to purchase the materials and have a contractor to rebuild your house, that's a completely different thing. Market value is what your house is worth on the market if it were to be purchased or you were to purchase it and replacement cost is how much it would cost to rebuild it.

So let's dig in to replacement cost 'cause replacement cost is really the most important when it comes to homeowner's insurance policies. On your homeowner's insurance policy you will see a coverage called Dwelling Coverage or Coverage. This is the estimated replacement cost of your home. It's the amount of money that the insurance company feels it would cost to replace your home and it's the major driver of the price of your insurance policy.

Now there's lots of different things that affect price but this Dwelling Coverage is based on the replacement cost and is a major factor in the price that you have. While replacement costs do vary widely around the United States, there is a rule of thumb that a standard home should be insured for, and I would say all homes should be insured for at least a $125/square foot.

Now it really does depend on where you live, how accessible materials are, how accessible building your home would be if you're in the middle of a big city and something bad happens, it's a lot tougher to rebuild that house in that space than it would be if you're in a suburban neighborhood or something of that nature, but a $125 is kind of the bottom side of what I would expect your replacement to be, $125 per square foot.

If you have a much nicer home, a custom home, you may see $200, $250 a square foot, I even see higher than that. It obviously goes up as you have more custom finishing. So if your home is a custom home, it's going to cost more to rebuild than if it was a standard home built in a neighborhood that was all built at the same time or something like that. So somewhere between $125 and $200 of square foot depending on the quality and custom nature of your home.

So here's an example, if you own a fairly standard home with 1500 square feet, and you could just multiply that 1500 times a 125, and you would figure that your dwelling coverage should be somewhere around $188,000. Now you should definitely talk to your insurance agent and ask them if you'd like for them to to show you the replacement cost estimate that they created.

I'll talk real quickly about replacement cost estimates though, they have very general information, so generally when you look at a replacement cost estimate, it has a lot of misinformation like it'll say 70% of your house is carpet when really a lot of it is hardwood or something like that. We don't know everything about your home. We haven't walked through your home most of the time and so we're generalizing, we're getting very general information about your home and coming up what we feel is a replacement cost and hopefully that is pretty close and some of these numbers can help you figure that out.

But you can ask an insurance agent to show you the replacement cost estimator that they created and they should be able to provide you that for you. So what if you underinsure your house? What if you insure your home for less than the actual replacement cost? Well, if your house burns down or is hit by a tornado or something like that, the insurance company is only going to pay the dwelling coverage the limit of liability on that coverage A line.

So, if they're rebuilding your house and they ran out of money because they ran out of that coverage, they're gonna stop even if it's 75% done and you're gonna be stuck paying for the rest of rebuilding your house in that situation unless you have one of two different kinds of coverages that I think are awesome and great companies always provide, which is Extended Replacement Cost or Guaranteed Replacement Cost. These two endorsements to an insurance policy or additions to an insurance policy give you some extra coverage.

Extended Replacement 

Cost is often 25% more than what your dwelling coverage is. Guaranteed Replacement Cost is even better than that. So essentially, these coverages build in a buffer so that if your number is wrong and you have to rebuild your house, the insurance company is gonna pay even more than the actual dwelling coverage. The most common example of that is if a tornado came through and took out 40 or 50 homes in a town, what would happen to the price of wood in that town?

Well, likely the price of wood would skyrocket because the supply would be lower than the demand in that situation. Suddenly, to replace your home, it's gonna cost a lot more money than what we thought it would be in a normal situation. This is why having Extended Replacement Cost or Guaranteed Replacement Cost can really help you out even if you have your replacement cost figured correctly on your insurance policy.

So make sure your policy has one of those two options on it. And like I already said, it provides extra coverage if your replacement cost estimate isn't correct or if the price of materials changes because of some situation like a tornado taking out a lot different properties at the same time. Let's talk about how market value affects your insurance policy.

Well frankly, it really shouldn't have anything to do with insurance. Market value and insurance are not really related to each other at all. Insurance is all about replacement cost, what it would cost us to replace your home. Market value has nothing to do with it, but occasionally there are some scenarios where market value will play into your insurance policy.

If your mortgage is for more than the replacement cost of the house, so market value in your town is higher than it would actually cost to replace your house, a lot of times, the mortgage company will require that the insurance company raises the coverage and this is kind of a bummer 'cause in the end, that coverage wouldn't be used because again, market value has nothing to do with replacement cost.

But often times a mortgage company will make you cover the amount you've borrowed from that mortgage company on your insurance policy whether it actually reflects the replacement cost or not. So that's one time that market value could come in to your insurance policy. Another is sometimes you buy houses for way less than the replacement cost. If you have a town where market value is very low, a 1500 foot house is gonna cost around $125/square foot to rebuild no matter what the market value is in your town.

So when market value is low, often times people feel like well, I bought this house for $80,000, why do you want to insure it for $200,000? And the answer is because we're not insuring for market value, we're insuring for replacement cost. But in some scenarios, you really have to be careful with these kinds of policies and make you understand but there are policies out there that can insure for less than the replacement cost, you just have to know it's not gonna rebuild your house. If your house were to burn down, you are only gonna get the limit of liability that you put on the insurance policy, it's not gonna completely rebuild your house.

But if that's something that you want and you're comfortable with, then there certainly are policies out there. Alright, so what we addressed in this article, well we talked about the quick definitions of replacement cost versus market value. Hopefully you know the difference now and you're super clear on that. We also talked about how replacement cost affects your insurance and how market value affects your insurance as well.

And if this article helped you think it could help others, please go ahead and share it and make sure that other people can enjoy it and learn from it just like you have. I always say good information is only great when it's shared with others. Until the next time, have a wonderful day.

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