UPDATED: Sep 2, 2020
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There are lots of confusing terms and jargon when it comes to insurance, and homeowners insurance is no exception. Understanding terms in your policy can be essential in avoiding common home insurance pitfalls, though. Two terms that seem to mystify many consumers are “Replacement Cost” and “Actual Cash Value”.
If they are confusing you too, then you’re not alone. But if you don’t learn the difference, it may end up costing you a lot of money. We’ll help clarify the differences in homeowners insurance between replacement cost and actual cash value here, though.
We’ll delve deeper into the differences below, as well as offer useful suggestions that can help you save money on your annual premium. One of the best ways to save is to compare multiple quotes, which you can do right now with our FREE insurance comparison tool.
When you file a claim with your homeowner’s insurance company, they have one of two ways of determining how much money they will pay out (assuming your claim is honored): replacement cost, and actual cash value. To understand the difference between these two amounts, we’re going to use a hypothetical damaged refrigerator as an example.
Let’s say that, due to some faulty wiring in your home’s electrical system, your fancy, expensive refrigerator gets fried and rendered useless well before the warranty runs out. Since there was nothing wrong with the appliance itself, your warranty may not apply to this particular situation, so you’ll have to file a claim with your homeowners insurance company in order to get compensation for your fridge.
If your claim is honored, and your insurance company replaces your appliance at replacement cost, then your insurance company will basically be buying you a new fridge. Obviously, they’re not going to let you run wild at Home Depot and pick out the fanciest, most expensive fridge you want. Another important aspect of replacement cost is that the claim funds must go to repairing or replacing your damaged property with a comparable device, comparable material(s), and must be used for the same purpose. So just like you can’t replace your broken, mid-range fridge with nicer, more expensive one, you also can’t take your awarded claim funds and purchase a new propane grill instead of replacing your broken refrigerator.
When it comes to replacement cost payouts, most insurance companies assign this designation to the Part A coverage of your typical HO-3 policy by default. Part A is the coverage that protects your dwelling (or external structure) of your home. Therefore, if a hail storm damages your roof, a neighbor kid throws a baseball through your window, or a large tree falls into the side of your house, you should receive enough money to repair the damages and make your home as good as new. Keep in mind though that because you are receiving a higher payout per claim, your annual premiums will be higher than if you applied actual cash value. As far as your insurance company is concerned, this helps even out the shared responsibility between you and your provider. Also, don’t forget that the more claims you file, especially for damages insured with replacement cost coverage, the higher your annual premium will be.