Home Insurance is an important item in a home purchasing process but only given less important compared to others. If you are financing your home using a lender, lender needs a home insurance rider with replacement coverage as part of the closing document. Otherwise lender won’t allow you close on your home. That’s standard requirement in many states. But if you are buying on cash, it’s up to you whether to have an insurance policy to insure your home for unforeseen natural disasters and accidents like hurricane, fire or theft. But I strongly recommend to have an insurance coverage to secure your well earned asset otherwise it would be too late to worry after it happens.

Many of clients either call for reference to an agent or questions about types of coverage and how much should the coverage should be and so forth. I am hoping to cover most of their questions in this blogs post so it can help as future reference.

If you recently brought a home and happen to shop a insurance, you might have shocked to hear the premium was too high and coverage amount for your property/Dwelling (as insurers call) is quoted for far greater than the amount that you paid for the house. You might think, why should I take more coverage if I only paid less than the coverage amount. You also might wonder about the reason why someone should want more coverage amount? Reason, the agent or insurer is recommending you to take replacement cost coverage rather than its actual cash value. That’s a good thing whereas others will sell a cheap insurance to cover only cash value. Be careful! Let me shed some basics for you to understand better so you can appreciate the benefit.

What is Replacement Cost coverage?
It is the amount of money it would take to repair, replace or rebuild your home with materials similar to the kind and quality used in constructing your home. If replacement cost is used to determine claims on your home, there is no deduction for depreciation, a decrease in value over time due to age or wear and tear. It should be the recommended coverage for any new or older homes if you really want to get back everything you lost. Insurance companies will pay 100% of the cost needed to replace your current home taking into consideration current market conditions.

On other hand, the actual cash value method for settling loss claims is the amount of money needed to repair or replace your home based on its depreciated value. It means you’ll only receive final amount after subtracting the depreciation value of home for those many years which is less money to rebuild or replace your home.

For example, if your replacement coverage for dwelling is $125,000 and unfortunately your house burns down after 5 years, they will pay 100% cost to replace your home. On actual cash value, they will take the replacement cost minus depreciation for 5 years and pay the rest of the money which might not help you to rebuild the house. You might saved few hundred dollars for 5 years but ended up losing thousands when something really happens.

Replacement Coverage – Advantages
It might cost more than double or triple premium to get replacement cost but it’s worth it when something happens. Construction costs increase over time, and the cost to rebuild your home with similar materials and workmanship could be higher than the amount that you could currently sell your home for. While the market price of a new home includes the cost of construction, the market price of a used home might go down because of age and deterioration. Replacement coverage takes every aspect into account to build/replace your home to the current environmental needs and that’s why it costs more. Don’t go cheap on insurances.

How much Insurance should I get?
Where replacement cost is used in determining coverage, the policy limit is usually set for at least 80% of your home’s replacement cost. If you fail to insure your home for at least 80% of the replacement cost, your insurer will assess a penalty on partial loss claims. If the agent says the dwelling should be covered to a certain amount which is usually 100%, you can ask him to do 80% of that amount which should still cover you on claims 100% and save you money on premium as well.

Let see an example: Replacement cost of your home is $125,000, 80% of that is $100,000 in coverage. If you insured your home for $100,000 and suffer fire damage of $20,000, your insurer will pay the full $20,000 loss claim. However, if you only insure your home for $80,000 to cover the mortgage and then suffer fire damage of $20,000, your insurer will pay only a part of the $20,000 fire loss taking into consideration the percentage of coverage taken compared to the recommended replacement cost. So always take coverage atleast 80% of the recommended coverage replacement cost amount.

You can also take additional optional coverages like personal property endorsement which provides more coverage and protection for such personal property as jewelry, furs, stamps, coins and fine art. Normally, these items are covered on an actual cash value basis with sub-limits that limit the items’ replacement cost.

As they say, Insurances are must to have’s and always pray we don’t get to use them. Don’t forget to check out the Texas state insurance department website and compare the rates and provider ratings before you purchase an insurance.

About Vijaianand Thirnageswaram

I am a Proud Realtor of Texas, trying to guide and help clients to find their dream home and educate them to buy them for right price. I am also a Candidate for CFP who has more financial knowledge which allows me share and educate clients in any financial decision making process.

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