How does the 80% rule work for home insurance?
If you don’t buy home insurance for at least 80% of the home’s replacement value, your insurer might not fully cover repairs or costs when you file a claim.[3] Let’s say a storm damages your home and it costs $50,000 to repair. If your home is worth $400,000 and you have $300,000 in coverage, you don’t meet the co-insurance requirement of $320,000.
Even though you don’t have to worry about the home’s replacement value in this case, you still won’t get full coverage for your claim. The insurance company will prorate how much it’ll pay.
How to calculate a payout if you don’t follow the 80% rule
To calculate how much to pay out in a claim for a homeowner that doesn’t follow the 80% clause, the insurance company will use a formula to multiply the cost of the damage by the amount of coverage you have ($50,000 X $300,000) and divide it by the amount of coverage your homeowner’s insurance policy should have ($320,000). In this example, the total comes to $46,875. Then the company will subtract the deductible. If you have a deductible of $1,500, the company will pay $45,375.
If you don’t follow the 80/20 rule, in this case, you’re paying $4,625 out of pocket rather than just the $1,500 deductible. When buying a homeowners insurance policy, you should keep this in mind, since it could cost you even more later.
Your premiums could be slightly higher when you add more insurance coverage. But paying more for insurance today might be less expensive in the future if you don’t have enough insurance to pay for repairs.
Some factors you should consider when calculating your replacement cost and how much insurance you should buy include:
Whether home prices have increased in your area in response to the real estate market
If you’ve made capital improvements to the house, including updating an older home or the home’s structure
Potential inflation in the cost of similar materials to rebuild your home; although, some insurance companies offer inflation guards in policies to combat rising consumer prices[4]
Market value vs. replacement value
It’s important to note that the market value of your home is different from the home’s overall replacement cost. The home’s total replacement value is likely to cost more since construction costs tend to rise over time.[5] Your home might be worth $400,000 now, but the money it takes for the new replacement cost of your home could be $500,000.
Your homeowner’s insurance policy should reflect the total replacement cost of $500,000, or $400,000 (80% of your home’s replacement value), rather than the $320,000 in coverage you might assume you need based on the market value of your house.
Learn More: Replacement Cost vs. Market Value