How Are Property Values Calculated for Homeowner Insurance?
Homeowner's insurance allows you to repair or rebuild your home if it gets damaged or destroyed and pay for injuries suffered by you, your family or visitors to your property. The amount of insurance on your home is known as the dwelling limit coverage. When you are in the market for a new home or refinancing your current mortgage, it is important to know how property values are calculated for homeowner insurance to ensure adequate coverage.
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Significance
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The most crucial aspect of acquiring homeowner's insurance is the cost to completely rebuild your home. Many homeowners mistakenly think they only need coverage based on the perceived value of their homes, so naturally if home values are down, then their insurance premiums should follow suit. The stark reality is when home values may be dropping, building costs may be rising, and the value of your home could be less than the cost to rebuild it.
Rebuilding Costs
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Insurance companies calculate the actual building replacement cost, rather than the market value of your property. Insurers use the insurance-to-value ratio (ITV) to stress a home's unique features, such as number of bedrooms and bathrooms, upgrades and construction materials. They do not base their calculations exclusively on square footage, but how much a contractor would charge to rebuild your house with all of its current features.
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Over Insuring
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Some homeowners may be tempted to insure their homes for more than the necessary amount. If the calculated ITV for your home is $400,000, but you just paid $650,000 to buy it, you would only need to insure the home for $400,000 to cover the ITV 100 percent. If your home is destroyed and has to be rebuilt, you are not paying to replace the land, only the home; therefore, the ITV is what determines adequate coverage.
Under Insuring
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On the other hand, if you find a great foreclosure deal on a house for $250,000 that has an ITV of $500,000, you would need to insure the house for $500,000 to adequately cover the cost of rebuilding. It is unlikely you would be able to rebuild the house for $250,000.
Co-Insurance Penalty
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Most homeowner insurance policies include a co-insurance penalty clause, which requires you to insure your property for a minimum of 80 percent of the ITV. Insuring your home for less than 80 percent could cost you significant money. If you sustain $25,000 of flood damage to your home and your coverage is less than 80 percent of the ITV, your insurance company divides the amount of coverage you do have ($200,000) by the amount of coverage you should have (ITV of $350,000), which means the insurer only pays 57 percent of the claim amount, or $14,250, leaving you with an out-of-pocket expense totaling $10,750.
Extras
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Once you know the necessary coverage for your home, you can add additional coverage (usually optional) for natural disasters and valuables, such as jewelry, computer equipment or other expensive items. Extra items such as these may not be covered by your dwelling coverage limit.
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References
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