When purchasing home insurance, it is very important that you know the difference between replacement cost and actual cash value. In short, the difference between the two policies is the amount of money you will receive in the unfortunate circumstance that you need to file a claim. A replacement cost policy will restore your home and/or belongings to their original state with nothing more than your deductible paid out of pocket. An actual cash value policy will restore your home and/or belongings to their original state with nothing more than your deductible and depreciation paid out of pocket. This subtle difference could mean the difference of thousands of dollars to you.
What does Depreciation mean?
As products and materials get older, they are typically worth less money. For example, you wouldn’t pay the same amount of money for a piece of lumber that’s 5 years old as you would for a piece of lumber that was cut 5 minutes ago. The decrease in value over time of used materials and goods is called depreciation. That’s where the discrepancy lies in the two types of policies; one covers depreciation, the other does not. That being said, there are advantages and disadvantages to both types of insurance policies.
Advantages of an Actual Cash Value Policy
The main advantage of an actual cash value home insurance policy is the price. Because depreciation is always deducted from what the insurer is responsible for paying (thus, the insurer pays less to fix your home), an actual cash value policy will always be cheaper. You can get more coverage for less money with an ACV policy.
Disadvantages of an Actual Cash Value Policy
The main disadvantage of an actual cash value policy is the increased risk that goes along with it. The increased risk is the potential to pay out thousands of dollars more than you otherwise would have had to pay if you had a replacement cost policy. With an actual cash value policy, there is no guarantee that your insurance company will cover the entire cost to fix the claim (minus your deductible). Instead, if your home and/or belongings are old, you may only get a portion of the money it would take to repair or replace everything that was lost.
Advantages of a Replacement Cost Policy
The best part about a replacement cost policy is the confidence of knowing all your valuables and home will be replaced with like-kind materials for nothing more than your current deductible. With a replacement cost policy, there is no guess work on how much you will have to pay or whether or not your home will be replaced with cheaper quality materials.
Disadvantages of a Replacement Cost
Replacement cost policies are always a little more expensive. You pay a little more to ensure that everything stays just as it was before the claim was filed.
Although home owners do have the option to choose between the two types of home insurance policy, the replacement cost policy is by far the most popular today. The type of policy you decide to have, however, is up to you. Good luck!
