What is Guaranteed Replacement Cost?
Posted on Dec 22, 2021
Losing your home to a fire or natural disaster is one of the worst things that can happen to any homeowner. What can make it even worse is finding out later that you lack the homeowner’s insurance coverage to rebuild your home back to what it was before the disaster.
This is why we recommend homeowners get guaranteed replacement cost coverage. It will pay the full cost to get your house back to its previous specifications, along with all the custom accessories you installed in the house, like your walk-in shower, granite countertops, and prized bookshelves.
Below, we’ll discuss in more detail what guaranteed replacement cost is, how it works, and its advantages and disadvantages. We’ll also discuss the difference between guaranteed replacement and extended replacement costs.
What is Guaranteed Replacement Cost?
Guaranteed replacement cost is a dwelling coverage enhancement you can add-on to your homeowners insurance policy. The policy pays the costs to rebuild your home, irrespective of coverage limits if your home is destroyed by a disaster.
How Guaranteed Replacement Cost Works
The mechanics of guaranteed replacement cost may seem convoluted at first, but it’s really quite simple. The insurance company values the home at its replacement cost before a fire, or natural disaster hits, i.e., when you begin your policy.
This entails some of the following items:
- Knocking down the undamaged portion of the home after a loss
- Clearing the lot and disposing of the debris
- Architect fees and other soft costs
- Cost of labor and materials (rising at more than 2X the rate of inflation)
For example, say that your guaranteed replacement cost limit is $500,000. Knocking down the rest of the home, clearing the lot, soft costs, and construction cost $500,000, then it would have been a perfect limit.
However, for every dollar over your limit, you would have to pay out of pocket. So if the final costs were $550,000 for your $500,000 limit, you would pay $50,000. That said, extended replacement cost expands coverage of your current coverage limit when rebuilding.
Valuing a home at replacement cost is a completely different method of valuing a home than a real estate value. This is because replacement cost is solely based on what it would cost to rebuild a home in the same manner after a covered loss.
Advantages of Guaranteed Replacement Cost Coverage
There are several advantages of guaranteed replacement cost coverage:
- Rebuild without replacement cost limits. Because the insurance company provides guaranteed replacement cost, i.e., they will cover the cost to rebuild the home, even if it exceeds the value of the policy.
- Options if choosing not to rebuild. Maybe you’d rather buy a home than go through the process of rebuilding your old one, or perhaps you were thinking of downsizing anyway. In cases like these, receiving the guaranteed replacement cost may be more beneficial than rebuilding. If someone with guaranteed replacement cost chooses not to rebuild, coverage is for the face amount of the policy.
This means that if you have a covered loss with the company and choose not to rebuild, you can walk away with the cost of rebuilding in your bank account. This is a huge bonus for those that may not want to rebuild after a fire or natural disaster because of trauma from the event or simply want a fresh start.
- Choose your own contractor. The claims process may allow you to choose your own contractor and will allow you to use many higher-grade materials in order to bring your home back to what it was before the loss. Most budget insurers would restrict you to the lowest cost contractor and only allow building materials from lower-quality providers.
These other carriers would also restrict the quality of the rebuild, for example, only allowing one coat of primer and one coat of paint, cutting corners to save them money whenever they can. However, with guaranteed replacement cost, you can rest assured that you’ll receive high-quality workers, materials, and your home will be just as good, if not better than it was before.
Drawbacks to Guaranteed Replacement Cost Coverage
There are also cons to consider with guaranteed replacement coverage.
- Higher premiums. Because a contractor can provide discounts up to 25-30% when rebuilding versus new construction, replacement cost coverage typically has higher premiums. Also, a rebuild might be much higher because if the home is damaged after a large-scale event, such as a hurricane, the short-term labor and materials costs will be much higher than they would be after a single loss event, such as a fire.
This is why the insurer providing guaranteed replacement costs gets to pick the limit. For example, paying higher prices to rebuild due to inflated lumber prices and high worker wages would be impossible.
However, you may be able to wait to start rebuilding your home or pay out of pocket to supplement the guaranteed replacement cost limit to ensure that your home will be built to your liking.
- It may not make sense for second homes or vacation homes. If you have a primary residence, you might not have the urgency to rebuild a second home right away. So, saving money on premiums might be a higher priority for you in this case.
What’s the Difference Between Replacement Cost and Extended Replacement Cost?
If you’re considering guaranteed replacement cost but would like to have extra coverage in any and every situation, you may want to consider extended replacement cost. Extended replacement cost is a common dwelling endorsement that serves as additional replacement cost coverage, increasing your policy limit by an extra 25% or 50% if costs exceed your original limit.
