Dwelling coverage: how much insurance to put on the house itself

Rebuilding cost, not market value

The price you pay includes the land, the location and the market. None of those burn down. Dwelling coverage should match what it would cost to rebuild the structure with similar materials, at today's labor and material prices, under today's building rules.

Rebuilding cost can be higher or lower than the price. In expensive areas where land is most of the value, it is often lower. In areas where construction costs have risen fast, or for older homes with detailed craftsmanship, it can be higher. Insurers usually estimate it with software, using details such as square footage, construction type, roof, number of stories and finishes. Check those details. A wrong square footage or a missing basement changes the estimate.

Replacement cost or actual cash value

State insurance regulators define the two settlement methods clearly. The Utah Insurance Department explains that replacement cost is what it takes to replace or rebuild your home, or repair damage, with materials of similar kind and quality, without deducting depreciation. Actual cash value pays after depreciation. The Colorado Division of Insurance describes actual cash value as replacement cost minus depreciation.

The difference grows with age. An actual cash value payout for a 20-year-old kitchen or roof will be well below what the repair costs. For the house itself, most buyers want replacement cost.

Utah's regulator adds that it is important to insure your home for at least 80 percent of its replacement value. Some policies reduce claim payments if you insure for less than a set share of replacement cost, so read how your policy handles underinsurance.

What your lender requires

Lenders require insurance because the house secures the loan. For loans sold to Fannie Mae, the Selling Guide requires property insurance on a replacement cost basis, with an exception for roofs, which must be insured but need not be on a replacement cost basis. Fannie Mae also recognizes that some policies settle personal property and non-building structures at actual cash value. Your lender will check your policy before closing, so get the declarations page to them early.

Because Fannie Mae's rule allows roofs to be insured without replacement cost, ask how your roof would be paid in a claim.

Extended replacement cost

After a widespread disaster, construction costs can jump. Some insurers offer extended replacement cost, which pays a set percentage above your limit if rebuilding costs more than expected. It supports what the Colorado Division of Insurance calls insurance to value: coverage enough to rebuild at current costs, to prevent underinsurance and reduce out-of-pocket costs after a total loss. Ask what is available and what it costs.

Keeping it current

Review the dwelling limit every year at renewal, after renovations and after major changes in local construction costs. Some policies adjust for inflation automatically, but an addition or a kitchen remodel will not show up unless you tell the insurer.

The bottom line

Set dwelling coverage to the cost to rebuild, not the price. Check the insurer's estimate for errors, choose replacement cost settlement and ask about the roof and extended replacement cost. Review the limit every year.