What Is the 80/20 Rule in Home Insurance?
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You likely already know the importance of home insurance. After all, it can help protect you should the unexpected happen. But most people don’t know or understand the 80/20 rule in home insurance, and this could cost them. Keep reading to find out what the 80/20 rule is, how it works, and why it’s important for you.
Most people purchase home insurance, but are they purchasing enough? This should be a concern of all homeowners, but often is overlooked. So, how does 80/20 home insurance work? You should purchase enough home insurance to cover at least 80% of your home’s replacement value. For example, if it would cost $500,000 to replace your home, you need to have at least $400,000 in home insurance coverage.
If you don’t, your insurance provider might not pay you the full amount of your claim in the case of damage. Your insurance provider will likely pay you a prorated amount.
So in the example above, if you only had $350,000 in coverage and you submitted a claim for $100,000 in flood damage, you would think you would have enough coverage. But the insurance company will see that you only have 87% of the coverage you need, and pay out 87% of your claim ($87,000). This leaves you short of the $100,000 you need to repair your home, which will now have to be paid out of pocket.
Not having enough coverage can cost you, big time. Getting the right amount of home insurance is not only practical, but critical to ensure you don’t also suffer a financial loss when dealing with home damage.
You might be wondering why this rule exists, but there’s a good reason. First and foremost, it helps protect you by encouraging you to have enough home insurance from the start. Otherwise, too many people would play hard and fast with their home insurance, and that’s risky for everyone, including the bank that provided your mortgage and your insurer.
But there’s another important factor: a higher amount of coverage means a higher premium for your insurer, which helps cover all the possible many claims, large and small, you might file on a home. It helps distribute the risk better, so that we can rely on insurance providers to cover our claims when needed.
An important distinction here is the market value of your home versus the replacement value, and they’re not the same. The replacement cost is the cost to replace your home entirely, including labor and materials. These costs tend to rise over time, so your replacement cost will likely be more than what you initially bought the house for.
Market value, on the other hand, is what you could currently sell the home for. You might be able to sell your home for $500,000, but it might only cost $250,000 to rebuild. That $250,000 would be what you’re covered for, not the $500,000.
There are many factors that impact your home replacement costs, including the age and size of your home, the materials used, current building codes, and more. Your insurer can calculate the replacement cost of your home, or you can have an appraiser tell you too. We can also help you calculate your home insurance costs.
With home insurance, it’s easy to set it and forget it. But that could end up costing you: your home will change in value over the years, and it’s important to make sure your home insurance still accurately reflects how much it would cost to repair it, so that you have the coverage you need, if you need it.
One commonly overlooked factor is home improvements. Upgrading or improving your home is a great way to add value, but this could impact your home insurance. For example, if you originally have coverage for $400,000 for a $500,000 home, but decide to renovate your kitchen, your replacement value has likely now gone up to $525,000. This means that your original coverage is no longer enough, and your insurance company won’t pay you the full claim should you need it. Ideally, you would increase your coverage to $420,000 right after the renovation, in order to be sure you’re covered.
If you haven’t already considered it, now might be a good time to consider home renovation insurance.
Not-so-fun-fact: inflation can also impact the costs to replace your home. Your home insurance should increase over the years to keep up with inflation, or you might fall short of the 80% coverage you need, over time.
If you weren’t aware of this rule before, it’s not too late. Simply contact your insurance provider and make sure you have enough coverage. The good news is that not having 80% coverage doesn’t mean you have no coverage; it simply means your insurance provider will pay a proportionate amount of your claim.
At the end of the day, home insurance should protect your home and free you from stress, and the 80/20 rule helps do just that, by giving you enough coverage and making it clear how much coverage you should have.
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Lauren Lewthwaite Lauren Lewthwaite has been freelance writing for almost five years writing content that ranges from health to insurance and everything in between. Lauren is also a trained translator in French and English and is a dog-mom to an adorable Australian Shepherd.
