When consumers shop around for homeowner’s insurance most only get a quote based on the amount of their loan. Here lies the problem, even though your mortgage company would be okay with you insuring to only cover the loan (their interest) you would be doing yourself a gross disservice, the reason being is, the amount you purchased your home for and the amount it would cost to replace your home are two different amounts and most times are at opposite ends of the spectrum.
In order to avoid customers from being under insured and possibly suing insurance companies for the difference it would cost to replace a home, insurance companies require that most homes be insured at Replacement Cost. Unless you are in the insurance industry some terms may be foreign to you to say the least. Terms such as Replacement Cost or Actual Cash Value are sometimes hard for even insurance professionals to explain to clients.
So let’s break down one term at a time. The term Replacement Cost for the most part is exactly what is says, it’s the type of policy that would cover to replace your home in the event of a total loss. The most common type of these policies are known as an HO3 Homeowner Policy, this policy covers damage to your home up to the replacement of your home if deemed necessary, including debris removal, for instance, if there is a fire to your home that results in a total loss, your policy would pay to have your home rebuilt to its original state prior to the loss.
Actual Cash Value is a little more complicated to define but for the most part has been narrowed down to mean the cost to replace with new property of like and quality less depreciation, depreciation meaning the decrease in value due to wear and tear. Sounds simple enough but many have seen that a grey area exist with this type of coverage, because determining depreciation can be tricky. These types of policy are called HO8 / Actual Cash Value policies and are usually geared toward older homes. These policies also have limited water and theft coverage.
The most important thing is that you have adequate coverage in the event there is a total loss, enough to not only satisfy your home loan but also to replace your home if the need arises. The difference in price to have a Replacement Cost policy versus an Actual Cash Value policy is minimal and could save you thousands in out of pocket expenses. Your home is your biggest asset; make sure you protect it.
Don Westerfeld has been active in the field of Insurance and Financial Planning since 1997. Don grew up in Indiana later moving to Lakeland Florida where he continues to reside with his wife and children. When he’s not in the office you can find him enjoying the great outdoors. He has served on several charitable business and non-profit organizations and continues to provide guidance, advice and support to local charities.
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