Replacement vs Cost Value
If you live in California (or in many other states) you’ve probably heard that it has become difficult to get reasonable hazard/fire insurance coverage. In fact, the state of California has had to set up its own insurance option (called the California Fair Plan,) to enable properties that insurers who operate in the state are unwilling to insure themselves, making hazard insurance (particularly because of fire risk) extremely expensive. While this is frustrating and costly, it has become well known enough that most agents, buyers and sellers are prepared in advance to navigate the process and pay more for lesser coverage.
The issue no-one is talking about is a little policy declaration that causes big problems. The good news is that it can also be avoided if armed with the information in advance. It has to do with two innocent sounding terms – replacement cost value and actual cash value and should be considered universally when choosing insurance policy coverages. Here’s an example that tells you what you need to know. Unless requested, many insurance companies may use replacement cost value for the majority of policy provisions but will stipulate coverage for older roofs at “actual cash value.” The problem with this is that a 15 year old roof might only have a useful life of five years so the insurer would only pay the “actual cash value” of the five years left on its life span, not the cost of a new roof in the event of a claim. “Replacement cost value” means that whatever it costs to completely replace the roof at the time the work is done is what the insurer is obligated to pay.
Needless to say, lenders don’t like this. Neither Fannie Mae or Freddie Mac will accept actual cash value on a homeowners insurance policy which can often make for a dramatic result at the end of a transaction. Since these two companies buy a bit over 70% of all US mortgages, it means that most borrowers need to be sure their entire insurance quote including the roof is at “replacement cost value” so it doesn’t hold up their transaction or cause unnecessary stress. The easy solution is to be sure that all insurance quotes are obtained with replacement cost value instead of actual cash value. It will provide better coverage and ensure that buyers have one less thing to stress about at closing.
