< 1 minute read|Published by FAIRWINDS

Homeowners Insurance Explained: Coverage Types and How They Work

Insuring your home guards against unexpected expenses, but what kind of policy is best for you?

Homeowner's insurance protects you from unexpected expenses and your home from unexpected events. When you're looking at insurance options, it’s important to compare policies to figure out how much you’ll receive in case something happens to your home. Two popular types of insurance policies include Replacement Cost Coverage and Actual Cash Value—but what do they mean?

Replacement Cost Coverage

This type of insurance reimburses you for the cost of replacing or repairing your damaged property with a new one of similar kind and quality. So, if something gets damaged, you'll get enough money to buy a new one just like it.

Here are some important things to note with Replacement Cost Coverage:

  • No Depreciation: This means you’ll receive enough money to replace your damaged property or item with a new equivalent based on the current market value.

  • Full Replacement Value: With this policy, you'll get enough money to fully replace your stuff and to fix or rebuild your home up to the value of your policy limit.

  • Will Cost You More: Since this coverage gives you more protection, you'll pay more in insurance premiums than Actual Cash Value policies.

Mortgage lenders like this type of coverage because it helps protect the property they're lending money for, and most lenders require it. FAIRWINDS, for example, requires this coverage for the same reason and to make sure borrowers are financially protected if something happens to the home.

Actual Cash Value

This method is another way insurance companies figure out how much your property is worth when it's damaged. They look at how much the property has gone down in value over time because of things like wear and tear.

Here’s what you need to know about Actual Cash Value:

  • Considers Depreciation: The coverage factors in the age, condition, wear, and tear of the damaged property when determining how much money you’ll receive. Your payout will be calculated by subtracting the depreciation from your property’s original cost.

  • Lower Payout: This could mean you might not get enough money to fully replace your stuff or fix your home like you would with Replacement Cost Coverage.

  • Less Expensive: Because this policy doesn’t cover as much, your insurance premiums generally will be lower than Replacement Cost Coverage.

Mortgage lenders may consider this coverage to be riskier because it doesn’t offer as much protection as Replacement Cost Coverage. It’s important to note that if you decide to go with Actual Cash Value coverage, this may impact your mortgage application. Although Replacement Cost Coverage may have higher premiums, you won’t have to worry about the risk of unrepaired damages, and your home will be fully covered.

Knowing the difference between Replacement Cost Coverage and Actual Cash Value is an important part of the home-buying process. Be sure to consider your finances, how old your property is, and what you want from your mortgage to choose the right insurance for you. Make sure to compare policies to find one that protects your home and fits your budget.