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Rising inflation could mean your home is underinsured

(NerdWallet) – The cost of home construction is skyrocketing due to inflation, and this could spell trouble for homeowners. Increases in the cost of lumber and other building materials, in conjunction with continued supply chain issues and labor shortages, could leave many homeowners underinsured if they need to rebuild after a covered insurance claim.

Should disaster strike, homeowners without enough coverage could find themselves digging into their wallets to cover the shortfall. Now is the time to be certain you have enough insurance to pay the cost of what it would take to rebuild your home, also known as replacement cost. Here’s what you need to know.

Know your home’s replacement cost

Insurers use replacement cost calculators to determine how much dwelling coverage is needed to rebuild your home. Information about your home, like its square footage, construction materials and the year it was built, are all incorporated into the estimated replacement cost.

You can also take steps to determine your home’s replacement cost on your own. One method involves multiplying your home’s square footage by the current cost of construction per square foot in your area, said Alan Himmel, a public insurance adjuster in Florida, by email. “You can get an idea of per square foot building costs by calling the builders association in your area, an insurance agent, or even … contractors.” Most estimates will range from $100 to $200 per square foot, according to HomeAdvisor.

You can also hire a contractor to provide a construction estimate, or have an independent insurance agency pull multiple homeowners insurance quotes to get a sense of what each insurer believes it will cost to rebuild your home.

Be sure to check the declaration page of your policy to see if you’re covered by replacement cost or actual cash value, especially when it comes to your personal property. Replacement cost coverage pays to repair your home or replace your belongings up to your coverage limits, without factoring in depreciation, or the loss of value over time. This means that your insurance company will pay to rebuild your home to the condition it was in before the claim, plus replace your personal property with new items, like paying for a new laptop regardless of the depreciated value of the lost one.

Meanwhile, actual cash value does account for depreciation and will likely mean having to pay the difference between what your policy covers and how much it costs to fully replace your belongings. For example, if your sofa is lost in a covered fire, your insurer will only pay for what the sofa was worth when it was destroyed, not the amount it would cost to replace it with a brand new one.

Consider extended or guaranteed replacement cost coverage

While you may be able to determine how much it would cost to rebuild your home today, it’s difficult to predict construction costs in the future. Even a catastrophic storm could greatly increase the cost to rebuild in your area overnight.

Extended replacement cost coverage can be added to a home insurance policy to help offset such uncertainties. This coverage will pay a percentage over your dwelling coverage limit if that amount isn’t enough to completely rebuild. For example, if your policy’s dwelling coverage is $100,000 and you have 25% extended replacement cost coverage, your insurer will pay to rebuild your home up to $125,000.

If you want full assurance that your insurer will cover the entire cost to rebuild your home, regardless of how much construction costs increase, consider guaranteed replacement cost. “The most confident I ever am when I sell a policy is when the client has a guaranteed replacement cost endorsement,” says Peter Conte, an independent insurance agent in New York City. “They can sleep better because, come time for a claim, they know they’re getting their house back.”

Guaranteed replacement coverage typically comes with a higher premium. It may not be available from all insurance companies, and it may not cover older homes.

Check for other coverage options

Many home insurance policies come with an inflation guard, which can offset the possibility of being underinsured due to expected inflation increases. An inflation guard will automatically raise your coverage limits to account for inflation when your policy is renewed.

Your premium may rise due to the inflation guard, but don’t lower your coverage limits just to save on home insurance. “The inflation guard is actually there to help you stay in line with the inflation rate of the U.S. dollar,” says Conte.

If you live in an older home, check your policy for ordinance or law coverage. In the event of a covered claim, this coverage will pay the cost to meet current building codes when rebuilding. Without it, you’ll likely need to pay out of pocket for any work done to abide by building codes, even if you have guaranteed replacement cost coverage.

If you’re still worried about being underinsured, talk to your insurance company or agent, as they’re best equipped to break down your policy, including what’s covered and what’s not. Be sure to keep them informed of any changes you make to your home, such as upgrades or renovations, so they can increase your coverage limits accordingly.



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