Updated June 4, 2021
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Your home is a valuable asset, and home insurance can protect your investment. But just like most types of insurance, homeowners policies offer varying coverage levels. Not all policies will pay the total cost to replace your home’s structure or your personal property if they’re damaged during a covered event.
Shopping around for a homeowners policy with adequate replacement coverage can help ensure you’re reimbursed for a covered loss in the event of a disaster. Here’s what to know about replacement cost coverage, how it works, and whether it makes sense to add to your insurance policy.
A standard homeowners policy typically offers replacement cost coverage for your home’s structure. This part of your coverage is often called dwelling coverage, and you can use payouts from it to replace damaged structural materials with those of a similar type and quality.
While replacement cost coverage for your home’s structure often comes standard with homeowners policies, personal property replacement coverage does not. When you have this coverage, your insurer can reimburse you in full for replacing belongings damaged by a covered event. For example, if a tree limb falls on your home and knocks your flat-screen television off the wall, personal property replace
ment insurance may cover the cost of a new TV.
Because replacement cost coverage potentially offers a higher payout amount than a policy that only pays actual cash value, adding this rider to your homeowners insurance can increase your annual premium.
Replacement cost and actual cash value are common calculations with homeowners policies, though they work slightly differently. With a replacement cost calculation, the insurance company determines the full cost of a covered item by today’s standards. So your damaged flat-screen could be five years old, but your insurer may cut a check for the cost of a brand-new TV.
Unlike replacement cost value, actual cash value calculations account for an asset’s depreciation. Instead of reimbursing you for the full cost of a new television, the insurance company determines the initial price of your five-year-old TV minus any depreciation. You’ll receive a check for that amount, leaving you to pay the difference for a new TV.
Depreciation example: Wear and tear over time reduce the value of property. You may have paid $1,000 for your flat-screen TV five years ago, but if you try to sell it now, you might get $400 for it. The $600 difference between its original value and what you could sell it for now is how much your TV depreciated.
A few types of replacement cost coverage are available:
Standard coverage: You can get reimbursed for up to your policy limit with this coverage. For example, if your dwelling coverage limit is $300,000, your insurance company may reimburse you up to that limit.
Extended replacement cost: With this endorsement (additional coverage) on your homeowners policy, your payout could exceed your policy limit by a certain amount, such as 25%. So if your existing dwelling coverage limit is $300,000, an extended replacement cost rider could provide up to $375,000 of coverage.
Guaranteed replacement cost: A tier above extended replacement cost coverage, guaranteed replacement cost insurance may pay you the full cost of replacing your house and belongings if they’re damaged by a covered event. While you wouldn’t be subject to a $300,000 or $375,000 limit, you’d likely pay higher premiums for this type of coverage.
If a covered event causes damage to your home’s structure or personal belongings, and you have replacement cost coverage for both, you can file a claim with your insurer for reimbursement.
Good to know: Depending on your insurance company, the claim-filing process can vary. Many insurers let you file a claim online or over the phone. As part of the claim, you’ll likely need to provide information about what was damaged and the event that caused it, as well as photos of the damage.
When calculating your payout, your insurer will consider the cost to repair or replace the damaged items or structures with comparable materials or products at today’s market price. They won’t consider depreciation.
The insurance company will probably send a claims adjuster to your house to assess the damage. If the adjuster determines the damage is covered, your insurance company will likely send a check for the settlement amount — the amount you’ll be reimbursed for repair or replacement.
Insurance companies determine replacement cost by looking at the current price of labor and building materials, your home’s interior and exterior features, the value of your personal property, and other factors.
If you’ve recently filed a claim and you disagree with your insurer’s evaluation of replacement costs, it’s best to call your insurance company directly and explain why. Whether they’ll offer a revised settlement amount will likely depend on your coverage levels and individual situation.
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Replacement cost coverage for your property can make sense, especially if you live in an area with a high risk of natural disasters. While adding this coverage can be valuable if a hurricane or fire damages your possessions, it will increase the cost of your homeowners insurance. Whether it makes sense for you depends on your situation, risk level, and budget.
Comparing homeowners insurance is one of the best ways to find an affordable policy. If you’re in the market for new coverage, get quotes from multiple insurers for the same levels of coverage.
You might also be able to increase your deductible if you prefer to pay lower premiums each month. Just be aware you’ll pay more if you end up filing a claim. Conversely, a lower deductible will likely mean higher premiums.
The amount of homeowners insurance you’ll need will vary based on your location, your home’s value, size, and features, whether it’s financed, and the amount of personal property coverage you want. Insurers generally recommend a set dwelling coverage limit based on these factors, and personal property coverage is often around 50% to 75% of your dwelling coverage limit.
You can estimate your home’s replacement cost in a few ways. For a simple calculation, the Insurance Information Institute recommends multiplying your home’s square footage by local building cost per square foot. But you can also work with an independent appraiser or your insurance company for a more comprehensive understanding of replacement costs.
Many home insurance companies offer replacement cost coverage, including major insurers like State Farm, Progressive, Allstate, and Farmers.
Jess is a personal finance writer who's been creating financial and business content for over a decade. Her work is published on Investopedia, MoneyWise, NextAdvisor, The HuffPost, and more. Prior to freelancing full-time, Jess was an editor at Investopedia, The Balance, and FinanceBuzz. Connect with her on LinkedIn.Learn More