As natural disaster season heats up, here’s how to choose between replacement home insurance and cash value home insurance

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Home insurance protects what is usually the biggest investment you can make: your home. In the event of a fire or natural disaster, that investment can be gone in minutes. You must have a cash value or replacement value home insurance plan in place to salvage or rebuild.

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Home insurance provides financial relief if a covered event damages your home, property or personal effects. It can also be paid when you are held responsible for an accident or injury.

But what events are covered? Some disasters, such as lightning, house fires and windstorms, can happen anywhere. Others, such as earthquakes and hurricanes, are more frequent in certain regions. Many home insurance policies cover fire, wind or snow damage, but do not cover flooding or earthquakes. These would require separate plans, which some insurers offer in the relevant areas.

Actual Cash Value vs. Replacement Cost Value Home Insurance

Actual cash value coverage is calculated by determining the market value of your home by taking its original cost, adding personal property, and then subtracting depreciation. An insurance policy with coverage based on cash value is cheaper to buy since depreciation is factored into the value of your home. Payments from a filed claim will be lower, but cheaper premiums might be the only option available to a homeowner.

Replacement Value (RCV) is the most recommended insurance coverage option because it can help policyholders insure a living situation that closely resembles their former home and possessions in the event of a disaster. Replacement cost policies give you more protection than actual cash value coverage, but have more expensive premium payments. Replacement cost insurance is recommended at best, as it does not take into account the depreciation of a house or its contents. If you factor in damage from potential natural disasters, RCV can literally save you from financial ruin.

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There are also variants of replacement cost insurance policies, but not all insurers – or circumstances – allow their purchase:

Guaranteed Replacement Cost Insurance is essentially an upgraded version of RCV coverage, but it also pays for the cost of rebuilding your home exactly as it was before any pitfall, even if the cost exceeds the appraised value of the home.

Extended cost new insurance policies cover you for an additional percentage – normally 20% to 25% – above the replacement value of your home, to account for price inflation.

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What type of home insurance policy should I choose?

To understand what type of coverage is best for your location and financial situation, consider the following three things before deciding if a cash value or RCV home insurance policy is right for you.

  • Policy cost: The most important factor to consider when shopping for home insurance is deciding what you can afford to pay in premiums. Ashley Kilroy and Jason Metz of Forbes Advisor point out that cash value coverage is generally less expensive than replacement value policies because the claims are usually of lower value.
  • Risk tolerance: Speaking of what you really need, being thrifty and missing essential coverage can come back to bite you. Are you prepared to pay out of pocket to purchase new items in the event of theft, damage or loss? Do you live in a region that requires additional home insurance in the event of a claim? These questions and many more will need to be answered. Forbes Advisor analysts say that although they are more expensive, RCV plans offer greater peace of mind because they expose you to less risk in the event of a claim.
  • House age: The cost of repairing an older home with original materials can be extremely expensive, to the point that some insurance companies don’t offer standard RCV coverage for older homes, write Kilroy and Metz. You may need to consider a modified insurance policy that will provide you with high quality and equivalent building materials if a replacement is needed.

Your home is more than just a roof over your head. It’s probably your most valuable physical asset and the one you probably can’t afford to replace in the event of a disaster. Protecting your investment with the right insurance is an essential part of being a homeowner.

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About the Author

David Nadelle is a freelance editor and writer based in Ottawa, Canada. After working in the energy industry for 18 years, he decided to make a career change in 2016 and focus full-time on all aspects of writing. He recently completed a technical degree in communications and holds previous university degrees in journalism, sociology and criminology. David has covered a wide variety of financial and lifestyle topics for numerous publications and has experience writing for the retail industry.

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