Financial Answer Center

The other crucial insurance concept for you to understand is the concept of replacement value. Your tendency, since you just bought this home, is to think that what you paid is what the home is worth. You are only partly correct. What you paid is what the home is worth from the standpoint of market value; but, not replacement value.

Insurance companies will be using replacement value instead of market value as their guide in determining your coverages and claims they honor. Replacement cost is generally what something costs to replace, so that if your home were to burn to the ground, the replacement value would be the cost to rebuild it. Unless you have purchased a new home or condominium, that cost may be far different from what you paid for the property.

SUGGESTION: When figuring how much coverage to purchase, don't forget to subtract the value of land from the total value of your property.

IMPORTANT NOTE: Even if your home decreases in value due to market forces in your area, fight the temptation to decrease your homeowner's insurance coverage. Although the home may fetch less money if you were to sell it, chances are that the cost to replace it hasn't decreased. Reducing your coverage could leave you short of the 80% rule, and exposed in the event of a loss.

So you buy your home, the lender gives you its guideline for minimum coverage, you work with your insurance agent to determine the proper replacement value coverage, and you select the higher of the two figures. It seems as though you've done all of your homework and made all the right moves. Be careful, you can still get burned. Your tendency will be to renew the policy every year and forget about it. Home construction inflation has been increasing recently. This means that replacement value today may be quite a bit higher than it was a few years ago. If you haven't updated your coverage each year for the effects of inflation, once again, you may be underinsured.

SUGGESTION: If your community has upgraded new building codes since the property was built, consider including a rider into your policy covering the cost of rebuilding to meet the higher standards.