Why Am I Insuring My Home For Half Of What I Just Paid?

The difference between Market Value (sales price) and Replacement Cost (insurable value).

The Real Estate Market in Colorado is booming, and as a result the value of many Colorado homes is going up. New home buyers are seeing the price of the homes they buy go up as well. Homeowners insurance is an important part of the equation of buying a new home, and in a market like we’re seeing in Colorado, it can bring up some confusing situations. Today we’d like to address a common question we receive from those who just purchased a home: “Why Am I Insuring My Home For Half Of What I Just Paid?”

That’s What I’m Insuring My Home For?!

You’re the proud owner of a great new home in Colorado, and in a competitive market like this, there’s plenty to be thrilled about. Once you’ve closed on the home or as you’re in the process of closing, homeowners insurance coverage comes into play. If you’re financing your home, likely homeowners insurance will be required, but even if it isn’t, you’d be wise to get it. Then when you first see the details of your homeowners policy something seems off… The expensive home you just purchased is only insured for half of what you paid for it. How can this make sense? You don’t want to lose out on the premium value of your new home!

Now isn’t the time to panic. This is actually quite normal for many homeowners all over the country. The reason has to do with the difference between Market Value, or the price you paid to buy your home, and Insurable Value (also called Replacement Cost), or the amount your insurance company determines is adequate to replace the house. Let’s examine the two to help you better understand.

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Market Value

The market value of a home is the price of the house itself, that is all structures on the property, as well as the land you own underneath it. Market value is primarily based on several different factors, or as they say location, location, location. The quality of transportation and schools around your home, the value of your neighbors’ homes, and the scenic views offered in the area all impact pricing. Size is also a factor in market value, which includes the size of your lot and the size of your home. Finally the condition of your home is another important factor in establishing its value. A “fixer-upper” is sure to command less money than a home that was just constructed.

The primary issue in evaluating market value vs. replacement cost is that several of these factors listed above have nothing to do with your insurable value. For example, it’s not going to cost more to replace your home because it’s next to the best school in the state! This said, let’s learn more about replacement cost.

Replacement Cost (Insurable Value)

Replacement cost is just as it sounds – it’s the cost it will take to replace your home in the event of a total loss. There are many factors that come into play when evaluating replacement cost. Examples include the cost of demolition to remove the old structure, contractors to work on the home, architects to design the home, the replacement materials of course, and more. All these elements make up the majority of your replacement cost. However what doesn’t need to be factored in replacement cost is the value of your land underneath the house. That value stays relatively the same whether your house is in good condition or you just experienced a total loss and need to rebuild.

To illustrate it another way, imagine a similar home to yours in a less desirable area. Each home is similarly sized and constructed from the same materials. As far as your insurance company is concerned they both cost the same amount to replace, even if the value of the land underneath them is different. This is why new home buyers in Colorado may be shocked to see their home is only insured for roughly half (with exceptions) of what they paid on the market. You have to take the value of the land out of the equation!

For more information, here is the verbiage on the Colorado Law pertaining to replacement value:

“10-4-114. Requirements on hazard insurance coverage for loans secured by real property. (1) No lender shall require a borrower under a loan secured by real property to provide hazard insurance coverage on that property in an amount exceeding the replacement value of the improvements on the property. (2) Any person harmed by a violation of this section shall be entitled to obtain injunctive relief and may recover damages and reasonable attorney fees and costs. (3) A violation of this section does not affect the validity of the loan or the mortgage or deed of trust.”

What Else To Watch Out For

Now that you understand how market value vs. replacement cost works, there are a couple other things to keep in mind. The first is to be sure you plan adequately and are as accurate as possible with your insurance agent. Trying to drive down the replacement cost on your policy will only lead to trouble for you down the line, especially in the event of a total loss. You’ll want the replacement cost to match how much it will take to rebuild your home as closely as possible. Work closely with your insurance agent to make sure they get all the information they need, and be honest!

Secondly, most homeowners will find it is wise to work with an independent broker over a captive or exclusive agent. An independent agent can shop around with different insurers to find the best coverage and price for your individual needs. Speaking with a captive agent will only result in one quote – the price and policy the company they work for offers. This can be especially important in a competitive market like Colorado. You’ve already spent a good deal purchasing your home, you’ll want to explore all the savings on insurance you can get!

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Final Thoughts On Market Value Vs. Replacement Cost

We hope this clears up some of the confusion around why your home may be insured for roughly half of what you paid. Market value vs. replacement cost can be a confusing subject, and there will always be some exceptions to this general rule, but we’re here to help you make sense of it all. Contact Square State Insurance with any questions about insuring a new home or the older home you just purchased, and we’ll make sure you get the best coverage for your needs.

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