Guaranteed Replacement Cost: What Homeowners Should Know

Updated December 14, 2022 | Reading time: 5 minutes

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If a natural disaster or fire destroys your home, your homeowners insurance is supposed to help you rebuild. But the cost to replace your house exactly as it was pre-disaster might exceed your policy limits.

Adding a guaranteed replacement cost endorsement to your insurance policy can cover the cost of rebuilding your home, even if it’s higher than the standard policy limits. Understanding how guaranteed replacement cost works can help you decide if you should add this coverage to your homeowners insurance.

What is guaranteed replacement cost?

Most standard homeowners policies pay for replacement costs if your home suffers structural damage, according to the Insurance Information Institute.[1] These policies generally pay more than the actual cash value — the value of your damaged property minus the cost of depreciation. If your home is structurally damaged, you’ll receive a payout that will cover the repair or replacement using materials that are similar to those originally used.

Even though most standard homeowners policies cover replacement costs without subtracting depreciation, it’s not a guarantee that you’ll receive a big enough payout to completely replace what you lost.

A guaranteed replacement cost endorsement on your homeowners insurance policy pays for the total cost of replacing your damaged home (minus your deductible), even if inflation, increased demand, or new building codes mean the replacement cost is greater than your policy limits.

How does guaranteed replacement cost work?

Guaranteed replacement cost coverage ensures that you can afford to rebuild after your home is destroyed or profoundly damaged — even if the costs to rebuild exceed your policy limits. But keep in mind that guaranteed replacement usually doesn’t cover the cost of upgrading your home to meet building code standards, according to the Insurance Information Institute. And if your home is older, you might not be able to get this type of coverage.

To understand how guaranteed replacement coverage works, it’s helpful to look at the other typical replacement cost options that insurers offer:

  • Actual cash value: This is the amount of money your home would be worth at the time of the loss, which means depreciation is generally factored into your payout.[2] This is often the least expensive option for a homeowners insurance policy because it provides you with the least amount of coverage in the event of damage or loss.

  • Replacement cost: With this type of coverage, your insurer will generally work with you to estimate the cost of completely replacing your home, without deducting for depreciation. This coverage will generally pay up to the exact limit of your policy.

  • Extended replacement cost: Extended replacement cost estimates the cost of replacing your home but extends the cap by 10% to 50% more than your policy limit, which gives you a cushion if building costs go up unexpectedly.

For example, let’s say a hurricane destroys your 15-year-old home that has a market value of $300,000. You have a replacement cost limit of $325,000 on your policy, and it’ll cost $420,000 to rebuild the home.

  • With guaranteed replacement cost, the insurer would pay the full replacement cost.

  • If you had an actual cash value policy, you might receive less than even the market value of $300,000 from your insurer because of the depreciation of various materials. You’d be on the hook for paying the remainder.

  • If you had replacement cost coverage, you might receive less than the $420,000 needed to replace the home, since the policy limit is set lower than that amount. With a replacement cost limit of $325,000, you’d be on the hook for the additional $95,000.

  • If you opted for an extended replacement cost endorsement with a 25% cushion and your replacement cost is set at $325,000, you’d receive $406,250 and have to cover the remaining $13,750 out of pocket.

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Guaranteed replacement cost vs. extended replacement cost

Here are some more details on the differences between guaranteed replacement cost and extended replacement cost coverage.

Guaranteed replacement cost

This type of replacement cost is often considered the “gold standard” of homeowners insurance because it ensures that you’ll be able to rebuild your home, even if the cost exceeds your policy limit.[3]

This coverage does come at a cost, though, since you’ll pay a higher premium for it. Additionally, guaranteed replacement cost endorsements can be more expensive in certain areas, such as coastal regions or wildfire zones.

Owning an older home may also affect either the cost of a guaranteed replacement rider or your ability to add one to your insurance. This is because older homes may have unique features, such as plaster ceiling molding or leaded-glass windows, that would be prohibitively expensive for a modern construction team to recreate. Some homeowners insurance providers only allow you to purchase a modified replacement cost policy, which will replace the older features of your home with the closest modern equivalent.

Finally, if you do purchase a guaranteed replacement cost endorsement, you may be required to alert your insurance company any time you make an improvement to your home that’s worth more than a certain dollar amount. Be sure to ask your insurance company what its requirements are when adding this type of coverage to your policy.

Extended replacement cost

Extended replacement cost coverage may be sufficient to protect your home in the event of a disaster, depending on how much you extend the policy. Generally, the higher the percentage of the replacement cost you add to the endorsement, the higher you can expect your premium to be. This means that choosing a 10% extended replacement cost may save you money in premiums compared to a 30% extension, but it’ll provide you with a smaller financial cushion in the event of a natural disaster.

Extended replacement cost may also not be enough to cover your needs if your home is one of many affected by a natural disaster, since that can cause the cost of construction to increase as demand goes up.

Do you need guaranteed replacement cost?

Having guaranteed replacement cost coverage isn’t a requirement, but it can be a good idea if your home would be difficult or expensive to replace.

If your home is destroyed, only guaranteed replacement cost coverage will ensure that you can rebuild your home as it was before the disaster. Having lower coverage than guaranteed replacement cost could mean footing the bill for the difference between your policy limits and the full cost of replacing your home.

Guaranteed replacement cost FAQs

Here are answers to some commonly asked questions about replacement cost coverage.

  • If you opt for guaranteed replacement cost, your deductible will be subtracted from the insurance payout you receive to rebuild your home. The higher your deductible, the more you’ll have to pay out of pocket before your insurance kicks in to cover the remaining costs.

  • Replacement cost coverage recognizes that rebuilding your home after it’s destroyed in a disaster is more expensive than the market value of the home (how much it would be worth if you sold it). This coverage protects you by insuring your home for an amount of money that will allow you to rebuild. But keep in mind that standard replacement cost coverage may not be enough to fully pay for the cost of replacing your home as it was before the disaster.

  • Extended dwelling coverage, which may also be referred to as extended replacement cost coverage, provides homeowners with an additional financial cushion on top of the replacement cost limits for their homeowners insurance. If your home is unique or would be expensive to replace, it’s probably a good idea to look into either extended or guaranteed replacement cost coverage.

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Sources

  1. Insurance Information Institute. "Insurance for Your House and Personal Possessions." Accessed December 14, 2022
  2. National Association of Insurance Commissioners. "Rebuilding After a Storm: Know the Difference Between Replacement Cost and Actual Cash Value When It Comes to Your Roof." Accessed December 14, 2022
  3. North Carolina Department of Insurance. "Optional Coverage." Accessed December 14, 2022
Emily Guy Birken
Emily Guy Birken

Emily Guy Birken is a former educator, lifelong money nerd, and a Plutus Award-winning freelance writer who specializes in the scientific research behind irrational money behaviors. Her background in education allows her to make complex financial topics relatable and easily understood by the layperson.

Her work has appeared on The Huffington Post, Business Insider, Kiplinger's, MSN Money, and The Washington Post online.

She is the author of several books, including The 5 Years Before You Retire, End Financial Stress Now, and the brand new book Stacked: Your Super Serious Guide to Modern Money Management, written with Joe Saul-Sehy.

Emily lives in Milwaukee with her family.