What Is Replacement Cost Coverage, and How Does It Work?
If you don’t know the replacement cost of your home, you could find yourself underinsured.
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If a calamity destroys your home, your insurance policy suddenly becomes one of the most important things in your life. You'll rely on it to repair damage and replace your belongings — and you might need more coverage than you think.
As inflation and natural disasters push costs higher, it’s important to know the replacement cost of your home and how much insurance your policy provides.
What is replacement cost insurance?
Also known as replacement cost coverage, replacement cost insurance pays to replace a damaged piece of your property with a new one. This coverage can also be referred to as replacement value insurance.
A standard homeowners insurance policy generally includes replacement cost insurance for your house and other structures on your property, such as a shed or fence. So if your house burns to the ground, a replacement cost policy would pay to rebuild it exactly as it was.
Replacement cost coverage may also apply to the stuff in your house. With this type of coverage, your insurer would pay for a new laptop if someone steals your old one. However, many insurance policies cover your belongings on an actual cash value basis instead.
Replacement cost vs. actual cash value
An actual cash value insurance policy pays what your items are worth minus depreciation, or the loss of value over time. For example, if your sofa is destroyed in a covered fire, your insurer pays what the sofa was worth, not what it would cost to replace it with a new one.
Choosing actual cash value coverage usually saves you money on your insurance premiums. However, it could cost more in the long run if many of your belongings are damaged at once and the payout isn’t enough to replace them. Most insurers offer the option to upgrade to replacement cost coverage.
While actual cash value is commonly used for your personal property, it may also apply to your roof. So if a hailstorm damages your roof, your insurance company might only pay part of the amount you’d need to replace it.
Check your home insurance declarations page or call your agent to find out whether you have replacement cost or actual cash value coverage.
How does replacement cost insurance work?
When you file a claim, your insurer may not pay out the full replacement cost of your home or belongings right away. Instead, you may get an actual cash value payment first. Then you’ll receive the rest of the payout once you’ve replaced the item and submitted your receipt to your insurer.
Dwelling, other structures and personal property coverage are generally subject to a deductible. A deductible is the amount of a claim an insurer expects you to cover, so it’s subtracted from your payout.
How replacement cost value works
🌳 A tree falls on your home, damaging your 5-year-old roof. You file a claim to replace it. Your insurer estimates your existing roof is worth about $8,000. It’ll cost $12,000 to buy a new one and the deductible on your policy is $1,000.
💲In this example, the insurer would mail you an initial check for $7,000. This is the actual cash value of your roof ($8,000) minus your $1,000 deductible.
🧾 Once you’ve replaced the roof, you send the receipt from the contractor to your insurer. You’d then receive a check for the remaining $4,000.
Know your home’s replacement cost
While replacement cost insurance offers more financial protection, you could still end up underinsured if you don’t set your coverage limits high enough.
Insurers use replacement cost calculators to determine how much dwelling coverage you’ll need. The estimate is based on information about your home, like its square footage, construction materials and the year it was built.
You can also determine your home’s replacement cost. One simple method is to multiply your home’s square footage by the current cost of construction per square foot in your area.
The average cost to build a house is about $162 per square foot, according to the National Association of Home Builders (NAHB). You can also hire a contractor to provide an estimate or use our rebuilding cost calculator to get a sense of what it will cost to rebuild your home.
Consider extended or guaranteed replacement cost coverage
While you can determine how much it would cost to rebuild your home right now, it’s difficult to predict construction costs in the future.
To offset such uncertainty, consider adding extended replacement cost coverage to your home insurance policy. This coverage will pay an additional percentage over your dwelling coverage limit if that amount isn’t enough to completely rebuild.
Guaranteed replacement coverage often comes with a higher premium. It may not be available from all insurance companies, and may not cover older homes.
Example: Say the structure of your house is insured for $400,000. Here’s how upgrading to other types of coverage could change how much your insurer would pay to rebuild your home. (The table below assumes that extended replacement cost adds an additional 25% of coverage.)
Type of coverage | Amount |
|---|---|
Replacement cost | $400,000 |
Extended replacement cost | $500,000 |
Guaranteed replacement cost | Whatever it takes to restore your home |
Check for other coverage options
Here are a few other home insurance coverage options that could help you avoid being underinsured.
Inflation guard
Many home insurance policies come with an inflation guard, which can reduce the risk of being underinsured because of inflation. An inflation guard automatically raises your coverage limits when you renew your policy.
Your premium may rise because of the inflation guard, but don’t lower your coverage limits just to save on home insurance.
Ordinance or law coverage
If you live in an older home, check your policy for ordinance or law coverage. This coverage pays the costs of meeting current building codes when rebuilding after a covered claim. Without it, you’ll likely need to pay out of pocket for work done to abide by building codes, even if you have guaranteed replacement cost coverage.
Is replacement cost coverage worth it?
It could be. Consider replacement cost coverage if you don’t usually have enough savings set aside to cover large expenses. While your home insurance premiums might be slightly higher, you’ll face less risk of financial disaster in the long term.
If you’re still worried about being underinsured, talk to your insurance company or agent. They can break down your policy, including what’s covered and what’s not. Keep them informed of changes you make to your home, such as upgrades or renovations, so they can increase your coverage accordingly.
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