Replacement Cost vs Market Value Issues

You find a major bargain for a rental property in Detroit California and only pay $65,000 for a home, but then after phone calls to 5 different insurance agencies in the area, you can’t secure any insurance on it, or the single agent who agreed to insure it, wants to charge you a ridiculous premium because they want to insure the home for three times what you paid for it!! – What?? How frustrating that insurance agents aren’t willing to insure the home for what you paid for it!

Well here’s the thing! Insurance companies have replacement cost to market value percentage requirements.

What? I know what you’re thinking; here she goes again with that insurance lingo.

So, let me explain for those that want to walk down this road with me to understand why we crazy insurance agents have these types of rules and limitations.

When you purchase a home at a major bargain price perhaps due to a depressed economic area, if something happens to that rental property that you had a family with a 1 year signed lease in, do you want a check for $65,000? No! This is a 1,600-square foot home and you want another 1,600-square foot home that the family can live in and continue to rent from you.

Herein lies the major issue: We have all heard of arson and fraud. Two very unpopular insurance terms. What are the chances that someone paying $65,000 for a home who could insure it for $195,000 and collect that much when it burns to the ground, would do so again, and again and again??!!

From the insurance industry’s point of view, not only does the large discrepancy between purchase price and replacement value encourage fraud and arson, it would always be a losing deal for the insurance carriers as the number of total home losses would increase dramatically.

A good rule of thumb in California to be insured with a Standard Carrier is 80% to value; meaning there cannot be more than a 20% difference between what you pay for the home and what you insure it for. Some companies have lower and some have higher percentage requirements, but all ‘standard’ companies I have ever dealt with in my 30 years of writing home insurance, have a similar underwriting value requirement.

I will discuss the issue with high land (market value) and lower home replacement cost value in another article, but as with every blog I write, I encourage you to contact our agency if you have any questions regarding this matter.