Do You Have The Right Homeowner's Insurance?

The recent spike in the inflation rate could be a big risk for homeowners if you don't have the right type of homeowner's insurance.

There are three main types of homeowner's policies: Actual Cash Value, Replacement Value and Extended Replacement Value.

I think everyone should consider Extended Replacement Value. Yes, it will cost more than the other two types of coverage. But only Extended Replacement Cost provides some inflation protection, which can be so very important if you have a major loss and need to rebuild.

Given the rising price of many materials (wood especially) and rising labor costs, you don't want to find out when you make a claim that your policy will pay out a too-small sum to rebuild.

• The Problem with Actual Cash Value (ACV)

An ACV policy will have the lowest premium, but that's because it will pay out the least amount when you make a claim. With this policy, the insurer is only required to base a payment on the depreciated value of whatever was damaged or lost. If your roof is 10-years old, and you need to replace it after storm damage, with an ACV policy, your payout isn't for the current cost of a new roof, but the depreciated cost of a 10-year old roof.

• The Risk of Replacement Value

Your homeowner's insurance policy has a stated Dwelling Limit Coverage. This is different from the market value of your home. The Dwelling Limit Coverage is the maximum amount the structure (and its appliances, and certain possessions) is insured for. It does not include the value of the land your house sits on. That land isn't at risk. Just the home that's on it.

With Replacement Value, your payout if you have a total loss is limited to the stated value of the Dwelling Limit Coverage. But that may not be enough to rebuild and replace if prices for materials and labor have risen.

• Extended Replacement Coverage's Inflation Protection

With an Extended Replacement Policy, your coverage can be more than 100% of your Replacement Value. For example, your insurer may agree to cover costs that are 120% or more of your policy's replacement value. That can be a financial lifesaver if you have major repairs or a total loss, and you find the current cost to rebuild exceeds your policy's stated dwelling limit.

Not all home insurers offer extended replacement costs, so you may need to shop around. While it is wise to want to have your home and auto insurance at the same insurer to qualify for premium discounts, I wouldn't blindly stick with one insurer if it doesn't offer extended replacement value.

And as always, I recommend you choose a deductible of at least $1,000. The premium cost could be 20% or so less than if you opted for a $500 deductible. Besides, it's never smart to make small claims, as that can cause your insurer to raise your premium at renewal time. Being able to cover a $1,000 deductible for larger claims is just one more reason I want you to build up a big emergency savings cushion.