What is replacement cost?
Replacement cost is an insurance term that refers to how much it would cost to replace something, such as a home, using the same type of materials with which it was built. Replacement cost does not subtract anything for depreciation.
Replacement cost is something very different from the actual or current value of your home. The value of your home is what it would sell for on the market, which may go up and down over the years for several reasons, including the overall condition of the home and trends in the housing market.
However, replacement cost refers to how much you’d have to spend to rebuild the structure exactly as it is or as close as possible, given the current cost of labor and materials. This amount could be more or less than the value of the property, or what you’d expect to get if you put it up for sale.
Also called replacement cost value (RCV) insurance coverage, it is favored by many homeowners because it allows them to replace a destroyed or damage home with the same type of dwelling they already live in.
The other common insurance option, actual cost value, or ACV, is typically less expensive than replacement cost. However, it doesn’t cover what it would cost to replace the home as it is in the current market. Instead, actual cost value gives homeowners the amount they initially paid for the property, subtracting some of this for depreciation.
Learn more about roof insurance and ACV vs replacement cost here.
Replacement cost example
If your home is destroyed by a fire or a tornado and you have replacement cost insurance, your insurance company will pay for exactly what it would cost to build a new home to the current specifications as the one you lost. This includes using similar building materials.
Your home may actually be worth less than that amount, especially considering depreciation, but the insurance company still would pay what it would cost to build a comparable home.
Plus, replacement cost covers what it would cost to do this using current pricing, so even if your home cost less than that to build initially, you’ll still get paid what it would cost now, regardless of the difference.
Read more to understand your home insurance policy.