The Home Buyer's Korner

Information presented should be used for educational purposes only.

July 19th, 2014

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Home Owner’s Hazard Insurance Policy Requirements 

downloadThere are two basic types of hazard insurance coverage, Replacement Cost and Actual cash value. Replacement cost coverage is then subdivided into three types: 1) replacement cost, 2) extended replacement cost and 3) guaranteed replacement cost. Replacement cost coverage pays claims based on what it costs to replace the damaged portion of the structure up to the limits of the policy. This is the requirement for most lenders. The extended replacement cost coverage will pay an addition amount, depending on the percentage determined by the company, for example 110%, 125% or even 135%. Guaranteed replacement cost coverage will pay to replace the structure as it is currently built. Actual cash value coverage pays claims based on the depreciated value of the damaged portion of the structure.

As an example, imagine you had insurance coverage of $150,000 and a $500 deductible. There has been a fire and the kitchen was damaged. The cost to rebuild it is $30,000. Replacement cost coverage will pay $29,500 ($30,000 less the deductible). Actual cash value would pay whatever the insurance company believes the current value of the structure is. So if they believe it has depreciated 50%, they would pay out $14,500 and the homeowner would need to pay the difference.  The big difference is that any replacement cost coverage policy pays claims based on what it costs to replace old materials with new materials up to the limits of the policy. There is no deduction for depreciation. Actual cash value does not do this. That is why it is not acceptable to most lenders.

Also, regarding the coverage requirements. The amount of coverage needs to be equal the lesser of 100% of the insurable value of the improvements or the unpaid balance of the mortgage and the maximum deductible is $1000.

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