Whether you build a home or buy one, you’ll need homeowners insurance to cover any potential damages to your dwelling and personal property. But some policies fall short of covering all your losses — and not just because of policy limits or your deductible.

The payout you’ll receive from your insurer will depend on the type of coverage you choose: replacement cost or market value. Below, we’ll dive into the difference between the two, as well as the benefits and drawbacks of each.

Replacement cost vs. market value: What’s the difference?

Homeowners insurance policies use two ways to determine how much to pay in the event of a covered peril that damages or destroys your home or personal property. They either cover the replacement cost of the covered items or their market value, which is often referred to as actual cash value.

Replacement cost

Replacement cost policies pay the full amount needed to replace your damaged items with comparable items, even if the damaged item is worth less than the cost of the replacement.

Say, for example, lightning strikes a tree in your yard, and the tree crashes through your fence as it falls. A replacement cost policy would cover the entire cost of replacing the broken fence with a similar one (minus the deductible), even if the existing fence was old and in poor condition.

Replacement cost works the same way with belongings inside your home. If a covered plumbing emergency saturates your 10-year-old sofa and ruins it, a replacement cost policy will cover the cost of replacing the sofa with a new one.

The dwelling portion of most homeowners insurance policies provides replacement cost coverage for your home’s structure, but there are exceptions. An older home, for example, might have obsolete materials and architectural elements that are prohibitively expensive to duplicate.

In that case, the insurer might limit coverage. Or, if the home would need to be rebuilt differently to comply with modern standards and building codes, you might need to purchase an endorsement to your policy to cover the extra costs.^[1]

Market value

An item’s market value, or fair market value, is the typical price a buyer would be willing to pay for it on the open market. A number of factors determine market value, such as the item’s age, useful life, condition, style, and use.^[2] When these factors reduce the item’s value, they result in depreciation.

Take, for example, a decade-old refrigerator destroyed by a power surge from a lightning strike. Depreciation makes this fridge less valuable than a pristine 2-year-old model with all the bells and whistles. But even the newer refrigerator has depreciated — the very fact that it’s been used for two years means it has a lower market value than the $1,200 identical model on display at the store.

Market value coverage is limited to the depreciated value of your property. Your insurer will determine how much the item depreciates each year, then subtract that amount from the original value of your fridge for each year you’ve owned it. You’ll then receive the depreciated value of your damaged refrigerator, minus your deductible.

Should you insure your home at replacement cost or market value?

Your insurance agent can help you decide on the best coverage for your specific situation, taking into consideration your budget, your home’s value, and your other assets. But generally speaking, it’s best to insure your home for its full replacement cost.

Otherwise, the payout might not be enough to fully repair or replace your home in the event of serious damage or outright destruction. This could leave you with significant out-of-pocket costs — or without the means to make the repairs.

Take note that you’ll pay more for replacement cost coverage, and some policies require that you front some of the money yourself, at least temporarily.

Such policies break the payment into two parts. First, you receive the actual cash value or some portion of the home’s replacement cost so that you can begin repairs. The rest of the cost, called recoverable depreciation, is paid only after you provide your insurance company with documentation proving that the work is complete.

If your intent is to purchase replacement cost coverage, be sure to verify with your insurer that its payout structure works with your budget.

Personal property

You’ll also have to decide whether to insure your personal property for replacement cost or market value. For this, you’ll need to consider your policy limits.

You can decide how much coverage you need for these items to some extent, but homeowners insurance policies typically limit coverage to a percentage of the amount for which you’ve insured your dwelling. For that reason, it’s not always possible to insure the contents of your home at full replacement cost.

How to calculate the replacement cost of your home

Calculating your home’s replacement cost means figuring out how much your home would cost to rebuild. For that, you’ll need specialized information most consumers don’t have access to. A mistake in these calculations can leave you financially devastated in the event you need to file a claim.

Your best bet is to hire a professional appraiser to prepare a detailed replacement cost opinion based on the type of construction, the building materials used, and various other factors. Local real estate agents are one source of appraiser referrals, along with your state’s appraiser licensing board or commission.

How to calculate the market value of your home

Only an appraiser can determine your home’s market value, so hiring one is the best way to ensure that you select the right insurance coverage for your situation. They have access to data that’s not readily available to consumers, and they’re experts at putting that data into context to form an accurate opinion of value.

That said, you can approximate your home’s value using information on Zillow and other real estate listing sites. Look at recently closed sale prices on houses similar to yours, located in your neighborhood. The more recent and local the sales, the more similar the homes. And the greater the sales volume, the more accurate your estimate will be.

Replacement cost vs. market value FAQs