The first time you see the value your homeowner’s insurance has placed on
your home, it might shock you a little. That’s because the number is
probably nowhere near what you paid for your home, or what it is worth on
the market. There is a very good reason for this, and it can be a little
confusing at first. Before you panic, take a look at how an insurance
company values your home.
Reconstruction Cost Only
Your homeowner’s insurance covers the actual physical building that is your
home, along with everything that is in it. The purpose of homeowner’s
insurance is to make sure that if the worst were to happen, your home would
be restored to the same level as before the incident. So, if your home were
to burn to the ground, homeowner’s insurance would pay to completely
rebuild the structure and replace everything inside it.
The value that is placed on your home is based on a complicated system of
calculations used to determine what it would cost to rebuild your home from
the ground up. Things like the price of building materials and cost of labor
are all taken into consideration. What isn’t included in this amount is the
value of your land.
Why Isn’t Land Included?
Even if your house were to burn completely to the ground, you would still
have your land. You don’t lose that, nor do you lose the value of the land.
In many cases, the land on which the home sits is more valuable than the
structure itself, especially in high in-demand areas. When calculating the
value of your home, you insurance company does not add in the cost of
purchasing the land, because you don’t need to pay for that again.
What About Market Value?
Homeowner’s insurance isn’t really concerned with market value, because so
much of it is wrapped up in things like the land, the location, and the state of
the real estate market. All your insurance company is worried about is what
it would cost to recreate your home exactly as it was in that same spot. So,
market value and reconstruction cost really have very little bearing on each
other, except for the connection between pricey areas and the cost of
building materials which can be correlated.
The bottom line is, as long as your insurance company has the most accurate
information about your home—square footage, building materials used, and
all the important features—they can calculate an accurate amount of
insurance coverage for you. This reconstruction cost usually also has an
extra allowance of about 25%, just in case the calculations are off. In almost
all cases, this is more than enough.