How to estimate your home's replacement cost and make sure you aren't underinsured

Your home's total square footage and local construction costs are key factors in estimating its replacement cost. Peter Cade/Getty Images

• Replacement cost is the amount your insurer will pay to replace your home if it's destroyed by a covered peril. 
• Avoid reducing the amount of coverage you have in exchange for lower premiums. 
• Purchasing an inflation guard endorsement will adjust for rising inflation and fill gaps in your coverage.

Replacement cost is the amount it would take to rebuild your home if it's destroyed by a fire or other event covered by your homeowners insurance policy. It is essential to know this to ensure you are 100% covered. 

Several factors can affect your home's replacement cost, including inflation. Keeping on top of these costs and making sure you always have enough coverage to pay them can save you thousands of dollars in the event of a catastrophe.

What is the replacement cost of a home? 

Replacement cost coverage "pays for the cost of replacing the home (or personal property) without deduction for deprecation," according to the Insurance Information Institute (III). It is also the maximum amount your insurer will pay for structural damage to your home, says Ian Gutterman, CEO of Informed Insurance — an independent insurance agency.

On the other hand, actual cash value is the amount it would take to replace your dwelling or your home's content, minus depreciation. For instance, if your kitchen is ruined by a fire, with replacement cost coverage, your insurer would pay to replace the belongings in it and rebuild the destroyed portion of your home with materials of similar value.

The average annual homeowners insurance premium in the US was $1,272 in 2019, according to the most recent data from the III. However, the cost of homeowners insurance will vary widely based on various factors, including your home's value.

The table below illustrates the average homeowners insurance cost by home value in the United States, according to the most recent Homeowners Insurance Report by the National Association of Insurance Commissioners.

Source: NAIC 

How to estimate the replacement cost of a home 

Your homeowners insurance dwelling coverage will reimburse you for replacing or repairing home-related losses. Your policy's personal property coverage will replace or repair damage to the contents of your home, like furniture or electronics. 

It is quite challenging to estimate the cost of your home's replacement cost value, as this estimate is not your home's market value, says Gutterman. Two significant factors that will affect your home's replacement cost are its total square footage and local construction costs.

Here is how to ensure you get the most accurate replacement cost estimate: 

1. Determine what parts of your home need to be covered

Your dwelling replacement cost will include your primary home and other structures on your property, like garages or sheds. Older homes may have unique features such as ceiling moldings or carvings that can be fairly expensive to replace. If that's the case, consider purchasing a modified replacement policy to replace features of an old home with modern standard building materials. 

2. Get an estimate

There are multiple ways you can get an estimate on your home's replacement cost. The most popular is to get an appraisal from your insurer. Your provider will use the information on your property obtained by third-party companies and the information you provided on your application to come up with an estimate. However, estimates can vary widely from one insurer to the next, according to Gutterman. 

Many online independent insurance agencies also offer replacement cost estimates for free or at a low cost through their replacement cost calculators. Alternatively, you can hire a third-party contractor or an appraiser to offer an estimate of your home's value. This method tends to be the most expensive but the most accurate way to determine your replacement cost. 

Finally, you can estimate your home's replacement cost yourself by multiplying your local rebuilding cost per square foot by the square footage of your home. Consider using this method as a point of comparison with your insurer's estimate.

Remember that the figures you get are only estimates and may not be entirely accurate. Your home's actual value can vary based on many factors, including inflation. 

3. Take inventory of your personal belongings

Create an inventory that details all the contents of your home, from your furniture to your clothing. This will make filing a claim much easier and allow you to see how much coverage you'll need to replace those items if damaged. 

Your personal property is typically insured with actual cash value coverage. However, you can purchase replacement cost coverage for your belongings at an extra charge. 

High-valued items like expensive jewelry and electronics are targets of theft and are often susceptible to damage by other perils. Protect your investments by purchasing a special personal property floater for belongings that need significant coverage. 

How to ensure you have enough replacement cost coverage 

Multiple factors can affect your home's replacement cost, like its style, the type of exterior wall construction, and the number of rooms you have, according to the III. Inflation also significantly affects how much coverage you'll need for your home. As construction and labor costs increase, your home's value may not be the same as last year. 

Here are three ways to ensure you have enough replacement cost coverage for your home: 

1. Purchase an inflation guard: An inflation guard will adjust your coverage to account for inflation and may cover up to 125% of your home's replacement cost. It is usually offered as an endorsement, also known as a rider, for an extra cost. 
2. Update your coverage annually: Even with an inflation guard, there may be gaps in your coverage. Every year, adjust your policy limits to ensure you're completely covered.
3. Make your agent aware of major renovations: Speak to your insurance agent right away about any significant changes or renovations you have made to your home as they might affect your home's replacement cost value. 

Gutterman gives one crucial piece of advice to policyholders when looking at the replacement value of your home:

"When comparing policies, don't just look at the price, also look at the replacement cost the insurer is assuming," he says. "It may be the price is only lower because they assumed a lower replacement cost which means you are taking extra risk."