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Most people do not have the money to pay for a new house in-full at the time that they buy it. As a result, they will usually take out a mortgage or other financing to finalize the purchase.
When you finance your home, you will have to repay the loan to the bank over a period of years. During this time, the bank has an investment in the property. So, if something happens to your home, then you are not the only party who might lose out financially. Your lender will also still expect to be repaid their mortgage, even if a tornado were to destroy your home. It is currently that your need for homeowners insurance is critical.
Most mortgage lenders require property owners to purchase homeowners insurance. At this time, you must carry coverage that meets the lender’s expectations. Usually, they will institute a replacement cost value (RCV) dwelling coverage requirement on the property. Here is how it and its counterpart, actual cash value (ACV) coverage, work.
Replacement Cost Value Coverage
A RCV homeowners insurance policy insures your dwelling based on the price it will cost to rebuild, at today’s rates. Replacement cost value is not the sticker price that you paid for the dwelling and the rest of the property. Instead, it is the value of the house itself, which is different from the price of the property, even though it is the most substantial part of your property value in most cases.
The benefit of RC coverage is you will be able to repair or rebuild a damaged home to exactly the way it was before the loss occurred. However, the drawback is that you will need to periodically clarify with your agent that your coverage is still adequate, given that construction and replacement costs often change.
Actual Cash Value Coverage
An alternative to RCV coverage is actual cash value insurance, which is both exceedingly rare and inadequate for use in dwelling insurance. If the value of your dwelling decreases over time, such as due to age, then an ACV policy will only pay based on the value of the house at the time of the loss. This is far from adequate when it comes to building an entirely new home, or to making extensive repairs. These policies are seldom offered to consumers today.
Once your lender tells you what type of coverage they require, your insurance agent will be able to help you design the right benefits. RCV policies are by far the best coverage to carry, and your agent can ensure that you receive the right balance of benefits for your needs.
source: ITC
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