Okay, I know you have home insurance—you can't get a mortgage without it. But very few people know much about their coverage, and that can end up costing them big-time. Pull out your policy—call your agent and ask for a new copy if you can't find it—and check the coverage.
On the first page, you should see a section labeled Dwelling Limit Coverage. This describes the upper limit of what your policy will pay out in the event you make a viable claim. Your specific type of coverage should be either Guaranteed Replacement Coverage or Extended Replacement Coverage. If your policy is for Replacement Coverage or Actual Cash Value, you are underinsured.
As its name implies, Guaranteed Replacement Coverage pays whatever it takes to rebuild. That's the gold standard, but it's hardly available anymore. So the next-best choice is Extended Replacement Coverage, which will give you up to 20 percent above the stated dollar limit on your policy. Let's say your home, which is insured for $250,000, is destroyed in a fire. When you go to rebuild, you find out it's going to cost $300,000. With an Extended Replacement Coverage plan, you'll be in luck—20 percent above your $250,000 in coverage works out to be $300,000.
Either option is far preferable to a simple Replacement Cost Coverage, which limits you to the face value of the policy—$250,000, in the example above—or Actual Cash Value Coverage (ACV). If you have ACV, I want you to upgrade your policy ASAP. Your payout with ACV will be based on the depreciated value of the damaged property, and that's bound to disappoint you and drain your bank account. For example, if your roof was 15 years old when it was damaged, your payout will be based on the depreciated value of a 15-year-old roof. That's not going to be nearly enough to cover the cost of replacing it.
I appreciate that boosting your coverage ends up raising your premium cost, so let me try to ease that pain a bit with a couple of premium-cutting tips. If your current deductible is below $1,000, then I recommend raising it to at least that level. This will reduce your premium costs by about 10 percent or more and discourage you from making small claims, which can cause your insurer to raise your premium or refuse to offer you a renewal. Consider moving your auto and home policies to the same company, too. That can reduce your cost on each policy by about 10 percent.
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