Homeowners: do you know the difference between actual cash value and replacement cost?

As a new homeowner, purchasing home insurance can seem overwhelming. There are more insurance options and add-ons out there than there are options at a buffet!  It’s hard to know where to start -there are different companies, options that are expensive, options that are cheap . . . each covers different types of damages and all have a different deductibles. However, one important detail to never lose track of when purchasing home insurance for your new home is how your insurance company will actually reimburse you should you experience a loss.

When you buy home insurance, insurance companies will insure your home based on what they calculate it will cost to replace your home. From there, you can select from two different types of coverage policies either replacement cost or actual cash value.

 

What are the differences between actual cash value and replacement cost?

 

Though these two types of reimbursements may sound similar, they are not. Actual cash value and replacement cost value are two different methods that can be used to calculate how much money you receive if your property is damaged, lost or stolen.

Actual cash value takes into account any depreciation that has occurred over time and replacement cost value is based on the cost to fully replace your property at current value.

For example, if your policy covers your roof for its actual cash value, your insurance company will deduct depreciation from your roof’s overall value to calculate how much they will pay you. This means that if your roof is old it’s actual cash value is going to be significantly less than the amount it will cost to replace it.

On the other hand, if you have replacement cost coverage on your roof, your insurance coverage will pay what it will cost to repair or replace it without deducting depreciation.

 

Why would some homeowners choose actual cash value?

 

Some new homeowners may choose to be insured for their homes actual cash value because this option cheaper, but the amount that you save on your premium is “peanuts” compared to what it could cost if you have to make a claim.

 

How do homeowners choose between replacement cost coverage or actual cost value?

 

It’s important for new homeowners to weigh out the pros and cons of replacement cost coverage or actual cost value. While actual cost value may be cheaper, you will have to cover the gap between the cost of repairing the damage and the amount your insurance will pay. Recall the roof example stated above when considering which to purchase; the longer you own your home, the more depreciation becomes an issue and replacement cost coverage becomes more important.

New home owners should discuss the pros and cons with their insurance agent to find the coverage that is right for their home and budget. Always keep in mind, the better your home insurance coverage, the less money you will have to pay out of pocket should a disaster strike.