Short answer: Your homeowners insurance isn't based on what your home could sell for. It's based on what it would cost to rebuild your home after a covered loss.
This is one of the most common questions I hear when reviewing a homeowners insurance policy.
Most homeowners are comparing two numbers that sound similar—but they're actually measuring completely different things.
What someone would pay to purchase your home today.
Market value is influenced by factors that have nothing to do with the cost to rebuild your home.
Market value includes:
Think of it this way: Market value answers the question, "What could I sell my home for today?"
What it would cost to rebuild your home after a covered loss.
Reconstruction cost is based on today's construction costs—not what your home could sell for.
Reconstruction cost includes:
Think of it this way: Reconstruction cost answers the question, "What would it cost to rebuild my home today?"
Unlike market value, reconstruction cost does not include the value of your land.
Let's say your home could sell today for $375,000.
Land: $90,000
House: $285,000
Now imagine your home is completely destroyed by a fire.
The land is still there.
The insurance company doesn't replace your lot—it pays to rebuild your home.
If today's construction costs mean rebuilding your home would cost $390,000, then your dwelling coverage should be close to $390,000, not $375,000.