Insurance policies can be confusing, especially during the stress of purchasing a new home. Why is there a difference between your mortgage loan and the home insurance amount? How does this relate to the cost of replacing the home? These are vital questions to ensure you get the best coverage for your insurance. Here’s an overview of these terms and how they will impact your home’s coverage.

Loan Amount

This is the money you have borrowed from your lender. It will need to be repaid following the terms of your loan contract. The repayment amount can include additional costs, such as administrative and closing fees.

Replacement Cost

If a disaster were to occur, this would be the total cost of replacing your home. This estimate isn’t limited to the base materials required for rebuilding. It can also factor in things like construction company rates, local permit or regulation fees, and the time needed for this work to conclude. Some people might choose to include material possessions stored in the home as part of the replacement cost. These will often end up being high-end valuables that are proven with receipts and photos, and they may have a separate insurance policy to cover any loss or damages.

The replacement cost isn’t always the same as the home’s market value. The market value includes variables such as location, current market rates, and the value of the land itself. These are unlikely to have a major impact on the replacement cost but may have made a significant difference in the home’s market price.

Insured Amount

This will be the amount that is paid out by your home insurance company in the case of damages. Policies can differ on how this insurance is calculated. Some companies may insure the replacement cost, while others will cover the entire loan amount. At the minimum, most mortgage lenders will require that a home is insured up to its replacement cost. This is because if the home were to be destroyed, you would still be obligated to pay the remaining mortgage.

What Insured Amount Do I Need?

With these definitions in mind, should you insure the home’s replacement cost or the total loan amount? This will depend on both your mortgage amount and the home in question. Ideally, you would want the lowest possible insurance payments while remaining protected in the case of an emergency.

Some mortgage companies will insist that the home be insured to the full loan amount. This favors them if anything were to happen to the home, as the insurance payout will help to protect the remaining loan payments. However, the loan amount can exceed the actual replacement cost.

An example of this is in the case of a home with a high market value. You may have paid a higher price for the home due to its location, but this isn’t something that is considered in the replacement cost. Another example is if the price of the home included a valuable piece of land. The land itself is not being rebuilt if something were to happen to the home, so you might not want to pay for the land in your insurance policy.

Factors such as these can easily result in overpaying on an insurance policy, especially in locations with high-value homes due to their surroundings. In some states, such as New York, mortgage companies are not legally allowed to require insurance to cover the entire loan amount.

You deserve the financial security that the right coverage will bring, but understanding the terms of home insurance shouldn’t be a point of stress. If choosing a coverage policy is still a daunting task, remember that you can always consult an insurance agent for advice. They can help you to further understand your available options to ensure that you and your family are safe from future damages.