When shopping for homeowner insurance, you may hear the terms “market value” and “replacement cost” multiple times. It’s important to have a grasp of the difference. They are not interchangeable.

Market value is the selling price on the open market — how much someone will pay for the property. This value can increase when an area is trendy and decrease as people migrate elsewhere. If a home is in an area where the “sale pending” sign goes up as soon or sooner than the property is listed, the market value may be on the higher end. But if a home has been on the market for months or longer, the seller may decrease the asking price in order to be able to sell it, and the purchaser may get the home for a huge discount.

Replacement cost is the price to rebuild the house in the event of a total loss. A home’s market value and its replacement cost may differ significantly, and that can be where things get confusing. When you buy home insurance, the amount of coverage you purchase should be the amount that it would cost to rebuild the home, so that you have enough coverage to get back to normalcy as soon as possible.

These factors play into replacement costs:

  • Materials and labor. The actual construction cost of the home may increase from year to year and from area to area. If a home is being reconstructed in an area often hit hard by storms, the need for specific contractors or materials may make reconstruction of that home more costly.
  • Contractor’s overhead and profit. Contractors will charge to keep their business running and make a profit on the reconstruction of the home. It is important to keep this in mind: In the reconstruction of your home, the insurance company can be asking a builder to stop all other construction projects and focus on the reconstruction of your home specifically in a timely manner. This comes at a cost to the contractor – and you need to consider that cost in the amount of insurance you purchase.
  • Inability to maximize savings as compared with first-time builds. When a home is first built, material and labor costs may be lower because the contractor is purchasing material in bulk and may be paying multiple crews to construct several homes in the area at the same time. Because reconstruction is a one-time event, the builder will not receive the same savings on material purchases or labor because of needing to pay one crew to focus on the rebuild of one
  • Older home reconstruction guidelines. If the home being replaced is older, re-creating it using “like kind and quality” materials may add costs. Homes built before 1940 likely used “true dimensional lumber” that is not commonly used today.
  • Historic home registry restrictions. Houses on a local or national historic home registry often have strict guidelines for the reconstruction, including cosmetic and structural changes to the home.
  • Area building code conditions. Local building codes may restrict contractor access. For example, homes built in resort areas often can be accessed only during non-peak season. Some communities limit construction work to specific days of the week or times of day,

The next time you are shopping for homeowner insurance, avoid the temptation to obtain coverage for the purchase price of the home. When you assess the replacement cost, you may think, “My house isn’t worth that much.” Just remember your insurance purchase should not be a matter of how much your home is worth, but what it would take to rebuild. In the event of a total loss, you want to be back in your home – the way it was – as soon as possible.

Coverages described here are in the most general terms and are subject to actual policy conditions and exclusions. For actual coverage wording, conditions and exclusions, refer to the policy or contact Landmark Risk Management & Insurance.