Replacement cost vs. Market value
My home is only worth $120,000. Why does my insurance company want me to insure it for $275,000?
One of the biggest questions consumers have regarding homeowner's insurance revolves around the amount of insurance to place on their dwelling (home). When purchasing a house, the mortgage company requires the homeowner to obtain insurance prior to closing. Most consumers assume the amount of dwelling coverage will be equal to the amount they paid for their house. This is incorrect in some cases.
There are different methods to determine the value of a house. Market value is the price paid for your house. Replacement cost is the price or cost it will take to rebuild your house in the same spot, same size and same quality of construction, at today's costs. Insurance companies use the replacement cost valuation. These can be two completely different numbers.
For example, a home purchased in a depressed city neighborhood, may have a market value of $120,000. The exact house, located in a nice suburb, may have a market price of $285,000; however, the cost to rebuild the house after a loss would be the same in either location. The insurance company is looking to insure the home for the full replacement value, not the current market value. Remember, they are going to pay to build you a new home, not buy one for you down the street.