One of the most important yet often misunderstood considerations when reviewing a home insurance policy is the difference between a property's market value and a home's replacement cost. They are very different things, and in the event of a claim event, not knowing this can come back to zing you if you aren’t careful.
Market Value
Market value is, in essence, the price of a home agreed upon by a seller and buyer. When someone is buying a home, he is buying the following:
The house itself, which can include personal belongings like furniture or curtains
The land on which the house sits
Any other structures on the property like fences, tool sheds, or gazebos
Intangible assets like the neighborhood, convenience and school zones
Replacement Cost
Replacement cost is the dollar amount it will take to replace an entire house with another of equal quality and utility. Factors that influence this number include:
Labor
Materials
Overhead
Profit
Permits & Fees
Examples
A modest home in a highly desirable neighborhood may have a replacement cost that is well below the market value. On the other hand, a very grand home in a less than desirable area may have a replacement cost that is more competitive with its market value.
Since replacement cost isn't influenced by factors like the land itself, the neighborhood, and the supply and demand in the housing market, it is often lower than its market value. In times of higher inflation or labor and supply shortages, the replacement costs would be higher, but these conditions would likely influence the market value as well.
One factor that could greatly impact the market value of the house over the replacement cost would be the aesthetics of the property. In Virginia, the majority of homebuyers prefer traditional designs (45%), with 29% preferring modern designs. A very modern home in an otherwise traditional neighborhood may not command as much on the market as it would in a community with a greater diversity of home styles. The home would cost the same to replace in either location.
What You Have With a Mutual Assurance Policy
Mutual Assurance provides replacement cost on all of its homeowner policies. Each year, this cost is carefully evaluated to account for inflation, supply and demand, and labor prices so you can rest assured that should the unthinkable happen, your home will be rebuilt to the same quality and utility as before.
Sources: eyeonhousing.org