One issue that consistently confuses homeowners, especially first-time buyers, is the difference between the market value of the home compared to its replacement cost. The market value is what the home is worth on the open market. The replacement cost is what the home can be rebuilt for using like kind and quality. The two are often not nearly the same.
Market value can fluctuate with peaks and valleys of the housing market. Just look at the differences in housing prices in single-family homes sold during January – June 2007 to the same period in 2008. According to the Warren Group many towns in Eastern MA saw their median house prices fall by double digits in just one year. Conversely, according to the Boston Globe the median price for a single-family home rose 11% during the first eleven months of 2013.
Market values can also fluctuate wildly from town to town. The Warren Group’s data for 2007 showed the median sale price in Lynnfield to be $521,500 while the median sales price in Lynn was just $265,000. Now some of the difference can be attributed to the larger lot sizes in Lynnfield versus Lynn and more custom construction, but it also reflects the increased value of the land on which to build in Lynnfield. The same house built in both towns will cost more in Lynnfield because the land on which it is built will cost more.
Your average Massachusetts homeowners policy is not concerned with market value, however, it is only interested the replacement cost value of your home. It does not insure land. The typical MA home policy agrees to repair the home at replacement cost without depreciation as long as you have maintained the proper amount of coverage. Most companies will also offer endorsements onto the policy where the company will pay above the coverage limit as long as you have made a good faith attempt to insure your home to its replacement cost.
So what’s the issue? In many cases there is a wide discrepancy between the market value and the replacement cost. And, it can vary either way. At the peak of the housing market or in towns with hot markets you will see homes whose market value far out paces its replacement cost. Conversely, in down markets or towns with depressed markets you may find houses whose market value lags far behind its replacement cost.
For instance you might find a tiny single-family on a half-acre of land in Lynnfield go for $380,000 while the building could be rebuilt for $200,000 or less. On the other end you might find a large single-family in certain sections of Lynn going for $250,000 with a replacement cost closer to $400,000. The insurance company is interested in the replacement cost. The homeowner in Lynnfield can insure his house for $200,000 while the homeowner in Lynn would need to insure for $400,000.
Many home purchasers are told they must insure their homes to their outstanding mortgage amounts. This is not necessarily true. MA law prohibits the lender from requiring the borrower to insure the house for more than its replacement cost as long as the policy has a guaranteed replacement cost provision.
At Columbia we would be happy to do a replacement cost estimate for your home as part of a review of your homeowners policy. Please call us at 800-559-5553 or email me at jolson@columbiainsuranceagency.net to set up a review.