Insurance Q&A: “What is actual cash value homeowners insurance?”
Ultimately, if you suffer a property loss, the insurer will pay the cost to repair or replace your damaged property, or its depreciated value…whichever is less.
Your home’s ACV is its depreciated value at the time of a loss, so obviously it can change over time.
You may opt to purchase this type of home insurance policy if you are not “in for the long haul” with regard to your current residence.
Since you will receive the depreciated value of your home if there’s a total loss, you would not likely have enough money to rebuild the structure the way it was…you’ll get a check from the bank, but not for an amount large enough to rebuild.
There are many things to consider when entertaining an ACV home insurance policy. First, you will need to verify if such a policy is acceptable with your lender.
Secondly, be sure you understand how you’ll get paid in the event of an insurance claim, and make certain to insure your home for the correct value (if the insurer doesn’t choose the value for you).
Overall, if you love your home and want to live in it (or one just like it) for a long time, you’ll opt for a replacement cost home insurance policy, as an ACV policy would likely leave you short of a rebuild.
How to Calculate Your Home’s Actual Cash Value
Every insurer may use a different technique, but you might find the following method useful. Here are the steps:
Step 1. Calculate your home’s replacement cost (RC). This number can vary depending on where you live in the United States (there are online calculators available for this exercise). You might try multiplying your home’s square footage by $100 for an estimate.
This means you expect your home would cost $100 per square foot to rebuild. This number may be $300 per sq. ft. if you live in a mansion.
Tip: Your home’s replacement cost and its actual cash value will be the same number if it’s a brand new build.
Step 2. Determine your home’s depreciation. There is often a limit for depreciation allowance. Perhaps 1% for up to 30 years of age (30% total) is the maximum allowable depreciation.
Step 3. Subtract the depreciation allowance from the replacement cost estimate and voila, you have the minimum ACV for your home.
Here’s an example:
Year of Construction: 1985
Square Footage: 1,000
Your home’s replacement cost: $100,000 (1,000 sq. ft. x $100)
Your home’s maximum allowable depreciation: $27,000 ($100,000 RC x .27 – 27 years of age)
Your home’s ACV: $73,000 ($100,000 RC – $27,000 depreciation)
Again, each insurer’s calculation can be different. Your home’s ACV may be much lower if your insurer allows for $75 per sq. ft. replacement cost instead of $100 per sq. ft. ($54,750 using the calculation method above).
You will certainly want to work with an independent insurance agent (who represents several insurers) to find the insurer who “does it” the way you need it done!
Why You Need to Get It Right
Simply put, you don’t want to over insure or underinsure your home. Remember, the amount of money you receive will be the ACV as determined by the insurance company, which may not exactly match what you thought it was when you purchased your policy.
Guess too high and you’ll be overpaying for coverage you won’t ever see if you file an insurance claim. Guess too low and you could be leaving money on the table in the event of a total loss.
Your insurer will NEVER pay more than the coverage limit on your declarations page. You might like the idea of saving a few insurance premium dollars by guessing low, but will be pretty sad if you suffer a total loss and find you could have received an additional $20,000 after your home burned down.
The coinsurance provision in your policy contract may also come into play here. Your policy may actually have a penalty for not insuring your home within a certain percentage of its true ACV.
This penalty basically reduces the amount of ANY property claim payment by a percentage based on how “far off” you were on your calculation.
Of course, there is no penalty for over insuring your home – other than the fact that you will be paying for coverage you won’t receive in the event of a claim.
Tip: Some insurers will perform an inspection of your property after your policy is issued and give you the opportunity to insure your home to the value they believe is accurate. Fail to do so and the coinsurance clause can bite you at claim time.
Can I Insure My Home for Actual Cash Value?
This will depend on whether or not you have a mortgage. Remember, if you have a mortgage, you don’t really own your home. The bank does. Therefore, you have to insure it according to their rules.
Their rules usually dictate that you have a replacement cost loss settlement homeowners insurance policy. Why? They want to ensure their “asset” is replaced in the event of a large loss. Your home’s ACV may be less than what you owe on your mortgage. This would leave your lender “upside down” if the house was destroyed…and they won’t go for that.
You may also be subject to lender forced insurance coverage if you have a mortgage loan and fail to maintain coverage on “their” home. You want to avoid this at all costs.