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Understand the 80/20 Rule In Home Insurance

80/20 rule in Home insurance

When buying a home, most mortgage lenders will insist that you obtain homeowners insurance. This insurance serves as a safeguard for your property, shielding it from both interior and exterior damage resulting from various covered events like theft, fires, or natural disasters. It offers the reassurance that you can repair or rebuild your home if the unexpected occurs.

Nonetheless, to ensure you’re adequately protected, it’s crucial to adhere to the 80% rule, sometimes referred to as the 80/20 rule, in homeowners insurance.

What is the 80% rule?

The 80% rule in home insurance dictates that for full coverage from your insurance provider, your coverage should amount to at least 80% of your home’s total replacement cost value. Most insurance companies follow this rule closely, and it’s in your best interest to do the same. This ensures you won’t face penalties for being underinsured and guarantees that your coverage is sufficient should your home be damaged.

To follow this guideline, it’s essential to ascertain your total replacement cost, which indicates the expenses required to rebuild your home with current building materials following damage.

How do you calculate the total replacement cost?

Replacement value is typically calculated by multiplying the average local per-foot rebuilding cost by the square footage of the house. While calculating this value can be intricate, most insurance companies can provide an estimate for you. Nevertheless, here are the key factors contributing to determining your total replacement cost:

  • The square footage of your home
  • Any home renovations or enhancements, such as altering flooring, upgrading appliances and fixtures, replacing a roof, or installing new windows
  • The cost of materials to be replaced
  • Labor expenses in case of necessary repairs
  • The value of both interior and exterior components

Regularly reviewing your home’s total replacement cost and adjusting your insurance coverage is crucial to avoid being underinsured. For instance, if you’ve recently made improvements or renovations to your home, you may need to revise your coverage.

Let’s illustrate the 80% rule in home insurance with an example:

Suppose you acquire a home with a total replacement cost value of $400,000, and your home insurance coverage amounts to $300,000. If a fire results in $250,000 worth of damage to your home, it might be natural to assume your insurance policy would cover the full cost, given that the damage expense is lower than the coverage cost. However, this isn’t the case.

To meet the 80% rule, in a situation where your home’s total replacement cost is $400,000, you’d need to secure $320,000 in coverage (which is 80% of $400,000). Failing to adhere to this rule means you won’t be fully covered for the damages, and you’ll be left to cover a portion of the expenses out-of-pocket.

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