What the heck is replacement cost?

We have received a lot of questions lately from new homebuyers about the concept of Replacement Cost.  Questions that sound like “Why do I need to insure my house for more than the amount I paid for it?”  and “How did you come up with that specific dollar amount for the insurance on my home?”  It can be a difficult concept to grasp at first – besides first-time homebuyers just spent a lot of resources and energy to come up with what they feel is the precise value for their home.

Replacement Cost essentially means the cost to replace the property on the same premises with other property of comparable material and quality used for the same purpose.  Very rarely does the cost of the materials it takes to build a house equal the fair market value of the home.  Often this is because the cost of new materials are higher now than they were at the time the home was originally built, even if those materials are of the same quality.  This brings us to the concept of “Actual Cash Value” which considers the depreciation of the home over time into account.  Insuring your home for Actual Cash Value may save on premium but can also leave a house dangerously underinsured in case of a significant loss.

Some insurance carriers have their own calculation for determining replacement cost.  Others use formulas provided by independent appraisal firms such as Marshall & Swift.  These formulas consider square footage, building materials, building age, and various other factors to determine replacement cost for the entire house.  If you’re interested in what goes into determining replacement cost or are confused as to why the replacement cost on your home seems higher than it should be – we encourage you to check out Marshall & Swift’s website to better understand how insurance carriers determine the true value of your home.  The better educated you are as a homeowner, the more confident you will feel that your home is insured properly.