What Does "Guaranteed Replacement Cost" in a Homeowner's Insurance Policy Mean?

Get an accurate appraisal before you shop for homeowners insurance.
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When you carry a mortgage on your home, the bank or mortgage company insists that you keep it insured to at least pay off the loan should anything like a fire or other disaster happen. Most insurance policies don’t cover flood or earthquake automatically; you need to buy extra insurance if you live in an area prone to those natural disasters. You’ll be lucky if you can find a policy that gives you a guaranteed replacement cost.

The What and Why of Replacement Policies

If you are lucky enough to find one of the rare companies out there willing to offer guaranteed replacement cost for your house, that means that the insurance company will replace your home no matter how much it costs in today’s economy. For example, if you bought a house for $100,000 in 2000 and lost it in 2014, it may cost $150,000 to rebuild it to the exact specifications of your old house. A guaranteed replacement cost policy would shell out the $150,000.

Watch Out for Loopholes

Homeowners often believe they have that kind of policy when in fact there are enough loopholes in it to ride three bulldozers through. It’s the small print on homeowner policies that consumers don’t read, according to "The Wall Street Journal." The bank only requires that you carry enough insurance to pay off the mortgage, and the most common policies cover the estimated value of your home based on an appraisal, not on how much it would cost to build an exact duplicate. Insurance agents aren’t likely to point out the small print that refers to monetary caps on your coverage.

What’s Most Common in the Industry

The most common homeowners insurance on the market is what’s called “extended replacement coverage.” That usually caps out at about 125 percent of your home’s appraised value, which in theory should be enough to get you into a new house. When you add an “inflation guarantee” addendum to the policy, then that percentage will be tied to inflation and rise with the times so that inflation doesn’t eat up your replacement coverage.

Know the Terms You’re Reading

You really need to study your homeowners policy if you think you carry that guaranteed replacement coverage. According to Bankrate and "The Wall Street Journal," those kinds of policies started fading in the 1980s and have not returned, but if you can translate the verbiage in your policy, you’ll understand what you do have. For example, “actual cash value” really means replacement cost minus depreciation, and replacement cost actually means that the insurance company will pay for rebuilding your house – up to the amount stated in the policy.

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