There’s been a lot of confusion when it comes to the market value and replacement cost lately so we thought we’d address this issue once and for all!

Why is it important to know the difference?

The most common area that deals with replacement cost is insurance. Obtaining your homeowners insurance is usually about the last step in buying a home. You’re about to close and you just need to secure your homeowners (sometimes called hazard) insurance to seal the deal. Now, you know what the house was listed for and you’ve researched comparisons in the area; you know what other homes are selling for in the area. You’ve negotiated a price that you think is fair. Essentially, you’ve been dealing with market values this whole time. But when you get your insurance, the insurance company tells you they’re going to insure the home for a completely different amount that’s no where near what you paid for it or what it was listed for! (The replacement cost could be much lower or much higher than the market value depending on the economy and current market conditions. That’s a whole other blog post.)

It’s alright. Don’t panic.

When you insure your home, you’re insuring it for the replacement cost, how much it costs to rebuild your home, NOT the market value.

The market value of your home is what you could potentially sell it for. There are many factors that go into determining the market value, like current economic conditions, location of the home and desirability. This is how much someone would pay to buy the house.

Now, Replacement Cost is completely different. It literally means how much it would cost to replace or rebuild the house with another one exactly like it. The factors that go into determining the replacement cost has nothing to do with location or current market trends, conditions or desirability of the neighborhood. You literally need to get estimates from several different contractors to build the house again from scratch. Replacement cost depends on how much they charge for materials and labor. You can think of it as wholesale cost. How much does it cost to BUILD. NOT, how much can I sell it for.

This is why it’s important to get your insurance with a large reputable company. The one I’m familiar with uses Marshall and Swift/Boeckh to help them determine this value. Marshall and Swift/Boeckh surveys the cost of labor and materials all over the country 4 times a year to maintain accurate labor and material costs. Based on the information you give the insurance company about your home, they’re able to come up with a replacement cost (sometimes referred to as rebuilding cost) that’s approximately 99% accurate. Smaller insurance companies that aren’t as reputable may not be able to calculate a rebuilding cost as accurate. When it comes to insuring your home, you don’t want to over insure and overpay for coverage you obviously don’t need. But you also certainly don’t want to under insure your home either.

We hope this clears up any confusion on market value and replacement cost of homes.

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