Why You Shouldn't Insure Your House for Its Market Value

Your homeowners insurance policy includes several types of coverage. Dwelling coverage will pay to rebuild your house if it gets destroyed by a covered peril. Many homeowners assume that they should choose an amount of dwelling coverage that’s in line with their house’s market value, but that can be a mistake.

Understand the Difference Between Market Value and Replacement Cost
A home’s market value is the amount a buyer would be willing to pay for it today. Market value is based on a house’s size and condition, how it compares to other homes in the area, the quality of the local schools, whether the house is close to stores and restaurants and a host of other factors. The housing market in a particular area is constantly in a state of flux for a number of other reasons, such as local economic conditions and access to jobs.

Replacement cost is how much it would cost to rebuild a house if it got destroyed. Prices for construction materials and labor can vary widely by location and over time. If your home is destroyed, there will also be bills to remove debris and clear the site before a new house can be built. A house’s replacement cost doesn’t include the cost of the land.

Make Sure You Have the Right Amount of Insurance Coverage
Since a home’s market value and replacement cost are determined by different factors, they can be completely different numbers. In some cases, the market value is higher, and in other instances, the cost to rebuild a house is more than its market value.

If you insure your home for its current market value, you might not have enough coverage to rebuild if it gets destroyed. In that case, if you decide to rebuild on the same site, you will have to pay the difference yourself or build a new house that’s smaller or constructed with less expensive materials than the old one. If you over-insure your house, you will have more coverage than you need and will pay more than you should in premiums. 

You can ask a local contractor to estimate how much it would cost to rebuild your house, but that might not be necessary. Your insurance company might estimate the replacement cost using information on your house and others in the area.

Periodically Review Your Coverage
If you make home improvements that raise your home’s value, those projects will also increase the amount it will cost to rebuild. Keep that in mind when you review your insurance coverage. You may need to make adjustments from time to time so you always have adequate coverage.

Inflation is another critical factor to consider. Costs for construction materials and labor tend to rise over time. You might have to periodically review and update your coverage, or your insurance company might automatically make changes so your coverage keeps pace with inflation.