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Replacement Cost or Market Value?

Here is a question we, at Lehigh Agency, are asked all the time:  “Why is my home insured for $200,000 when similar homes in my neighborhood are selling for only $150,000?”  This is a very sound question for which there is a very sound explanation.

Most homeowner insurance policies are based on what is known as replacement cost.  This figure reflects how much it would cost to replace the house in the event of a loss – to rebuild your home in the same spot, at the same size and same quality of construction.  Replacement cost takes into consideration the cost for current materials, labor, and removal of debris.  The current value of your home on the real estate market – the price for which the home sells – is known as market value.

Think about this:

Two, almost identical, 3-bedroom/2-bath homes with 2,000 square feet sold in the Pocono Mountain area recently.  One sold for $85,000, the other for $200,000.  Both homes carry a replacement cost of $240,000.  So, why the big discrepancy in market value when thereplacement cost is the same?   The market value of the each home is affected by variables including location, school district, neighborhood, and condition of the home.  The replacement cost, however, is affected by a different set of variables including the cost for current materials, labor, and removal of debris.  If both of these homes burned to the ground and were to be rebuilt in the same spot, at the same size and same quality of construction – at today’s prices – each home would be rebuilt at an average cost of $120 per square foot.  Therefore, BOTH homes would cost about $240,000 to rebuild.

Keep in mind that both replacement cost and market value are affected by the fluctuations in the economy including the costs of labor and materials and/or housing demands.  Sometimes the market value of a home will be higher than the replacement cost; sometimes the replacement cost will be higher than the market value.  Insurance companies will use a construction cost estimator to determine the replacement cost of your home.  Talk with your agent to be sure you are fully-covered.

I hope that wasn’t too confusing because next week’s blog is about stated value versus actual cash value!