For many Texas real estate investors, the past few years have been an amazing period of real estate growth and appreciation. Home equity has skyrocketed around the country, and it is always good to see your home equity increase. But there is an important question that many homeowners don’t consider: What does the surge in home values mean for your insurance coverage?
As the value of your home increases, the numbers involved in safeguarding it become more intricate. Not aligning the policy to today’s economic reality can put you at risk for debilitating out-of-pocket costs if a disaster occurs. The better you can anticipate how changes in property values relate to your coverage limits and what you must do next, the safer you’ll keep your biggest investment.
Market Value vs. Replacement Cost in Home Insurance
The biggest mistake homeowners make is thinking the house is worth how much it costs to fix or rebuild it. It’s important to know the difference between market value and replacement cost so your property is properly covered.
- Market Value: What a buyer thinks your house is worth in the current real estate marketplace. It is strongly affected by factors unrelated to construction materials, including school districts, neighborhood popularity, and housing demand.
- Replacement Cost: The total dollar value needed to rebuild your home from the ground up, using the same contractors and materials from the same manufacturer.
Your insurance policy should be based on replacement cost instead of market value. Your insurance company does not purchase a new piece of land at today’s price if your house gets blown over in a severe storm; it only pays for the lumber, concrete, roofing material, and labor needed to rebuild the house structure.
Your market value may go up as your replacement cost goes down, and the other way around is possible, too, since these two can reflect different economic forces.
Does My Home Insurance Automatically Increase When My Home’s Value Goes Up?
One of the misconceptions many homeowners have is that their policy’s limits automatically follow the economic changes. The answer is no – your insurance doesn’t automatically increase because this real estate market is hot.
Some contemporary homeowners’ policies include a clause called an “inflation guard.” A lot of modern home insurance policies have an “inflation guard” feature. A clause that increases the dwelling cover limits by a small percentage each year, normally 2% to 4% to keep them in line with general economic inflation:
An inflation guard is useful, but usually not enough to cover unexpected increases in local building costs or sudden surges in real estate values. If the price of building goes up 8% or 10% in one year, this will make you get further behind in your policy over time if it increases by that amount automatically. Depending on automatic adjustments alone can create a growing mismatch between coverage and reality.
How Much Has The Cost to Rebuild a Home Increased Recently?
It’s important to consider the intense strain on the construction industry to appreciate why policy levels may be lagging. Rehabilitation costs have risen significantly over the last few years due to supply chain issues, material cost fluctuations, and an extremely competitive labor market.
Industry data shows that construction and replacement rates in Texas have increased anywhere from 25% to 40% since 2019. The cost of essential building materials such as lumber, concrete, steel, and electrical parts has fluctuated greatly. Meanwhile, workers with special trades skills—such as electricians, plumbers, and framing carpenters—are scarce and have seen their labor costs rise sharply statewide.
Additionally, local building codes change over time. If your house was built 10 years ago and is severely damaged now, then you have to follow today’s more stringent building codes when you rebuild. The cost of these compliance improvements will increase the reconstruction bill and make it significantly higher than it would have been a few years ago.
The Hidden Risk: If My Home’s Value Has Risen, Am I Underinsured?
When property values and building costs surge past your existing policy limits, you face a very real risk of being underinsured. If your home has appreciated greatly without you changing your home insurance dwelling coverage limits, you may find yourself in a hole for thousands of dollars after a large loss.
Let’s say that five years ago the home insurance company had a dwelling limit of $300,000. If a fire or severe hail event is to happen today, and construction costs have risen to $400,000 to rebuild a structure of that same size, then your policy will still only cover the original $300,000 limit of the policy. You would have to pay $100,000 out of pocket to make your home complete.
Underinsurance isn’t just bad when it’s time for a total loss. A “co-insurance clause” requires coverage to be at least 80% of the actual replacement value, and many policies have them. When the value of your home decreases, such as when your home increases in value faster than your policy, the insurance company will apply a penalty, which may also affect the payout of small, partial claims, such as a damaged roof or a kitchen fire.
Staying Protected: How Often Should You Update Homeowners Insurance?
With the pace at which local economic conditions can change, you can’t afford to fall into the “set it and forget it” trap for your property protection. So, when should you update homeowners’ insurance policies?
You really should go through and review your coverage limits at least annually. When you get your annual policy renewal paperwork, that is usually the best time to do it. Going over your policy on an annual basis will ensure your coverage limits keep pace with regional building trends and changes in your home value over time.
When Should I Review My Home Insurance Policy?
While an annual review of your policy is the baseline, there are other times that it may make sense to review your policy outside of renewal time:
- Major Home Remodel: If you remodel your kitchen, finish your basement, or add a garage, you are increasing the replacement cost of your home.
- Higher-Quality Finishes: If you replace builder-grade laminate countertops with granite countertops or install premium hardwood flooring, this changes the math of what it would take to rebuild.
- Increases in Local Markets: If you observe that homes in your neighborhood are selling for significantly higher prices or that local contractors are charging premium rates, you need to revisit your policy.
Your Personal Home Insurance Services Texas
With all the inflation, replacement costs, and limits that you are concerned about in your home insurance policy, it may seem like you are stuck on your own. Your insurance needs and your home are unique to you and where you live. This is why you should work with personal home insurance services Texas experts to make sure that your limits are up to date.
Using your local, independent home insurance agency allows you to look at multiple options and compare quotes from many national carriers in a specific region. This way, you can make sure that you have the dwelling limits that you need, at a fair cost. It’s worth your time to know that your home will be covered if you have to rebuild after an accident or natural disaster.
If you want your coverage to match the replacement value of your home, contact McKinney Insurance Agency today to set up an appointment with an agent.