Replacement Cost vs Market Value: Home Insurance
The difference between Replacement Cost and Market Value is a simple concept, but oftentimes a hard one to see objectively. Some customers don’t like the idea of paying the premium for $250,000 worth of coverage on the home they just bought for $175,000. What they may not realize is that the cost of buying versus rebuilding a home can vary greatly.
A good way to look at Market Value is as the price a consumer is willing to pay for a home. This introduces new, often subjective, factors into the equation. Replacement Cost on the other hand is the objective amount that it would cost to rebuild a home with the same quality of construction at today’s prices.
Of course Market Value is not entirely subjective. It takes into account many of the same factors as Replacement Cost. The square footage and materials used in construction play an important role in both calculations. Consider the following factors that can affect the Market Value of a home without altering the Replacement Cost:
Location -- Examples that affect Market Value include school zones, crime rate and the condition of surrounding homes.
Acreage -- The land is part of the market price a homeowner pays, yet does not generally affect the rebuilding costs.
Real estate market fluctuations
There are also factors that affect Replacement Cost that are irrelevant to Market Value. Examples are:
- Debris removal. Replacement Cost takes into account the costs involved with demolishing any part of a home and removing the debris.
- Economy of scale. The cost to build a home in a new subdivision can be significantly lower than in an established neighborhood.
Because of these factors, a home’s Replacement Cost is often higher than the amount paid for it. Understanding these reasons can help your customers realize the need for proper coverage on their home, and help avoid situations in which they are underinsured.