Should I increase my policy limits when the rebuild costs greatly exceed the mortgage?

Question

I recently changed providers for my home insurance and as part of the process, they sent somebody to conduct a driveby inspection of the property to verify that there weren't any factors which would impact the terms of the policy.

Nothing came up from the inspection, but they did send a letter indicating that the policy's coverage for rebuilding was insufficient to cover the costs for rebuilding the property. I'm not sure how they could make such a determination from just a driveby, but for the sake of the question, let's assume that they are accurate.

Currently, my mortgage is around $140k and the insurance coverage provides somewhere in the range of $220k for rebuilding. Furthermore, the tax assessor values the property around $160k.

In the event that a disaster did occur which totaled the building, could I simply take the insurance payout to clear the debris and payoff my mortgage, then use whatever's leftover to buy a different house to live in? This would technically leave my current property's lot vacant, but without improvements I expect the taxes would be minimal and I could simply list it for someone that was interested in building their own house.

I suspect this is the nature of things when somebody burns their business down 'for the insurance money', but is this the case as well for home owner's insurance? For example, can the money only be used to cover costs associated with rebuilding the property, or can it be used for whatever the policyholder wants? With the insurance company low-key asking me to up my policy limits, I'm having a hard time envisioning what benefit there is to do doing so other than to be able to remain in a very similar house on the exact same lot and frankly if something totaled my house I'm not sure I'd want to stay put.

Answer 1

How much you owe and how much you pay taxes have very little bearing on how much it would cost to rebuild your home if a disaster strikes. It can very much be so that the market value of your home is less than what it would cost to build it from scratch. It is most definitely possible that the remaining mortgage balance that you owe is less than that either.

However the insurance is to cover a risk. If your home is destroyed, what are you going to do? Are you going to sell the land to someone else? If so, assessor value (or more likely, appraisal value) is relevant. Are you going to pay off the mortgage and forget about the house? Then the mortgage balance is relevant. Are you going to rebuild your home? In that case, neither the assessor value nor the mortgage balance are relevant, what's relevant is the costs you'd pay to achieve that.

So calculate the coverage that you need and want based on what you plan to do, and go with that.

Answer 2

I'm not sure how they could make such a determination from just a driveby,

They also have access the the public tax assessment documents. That tells them the square footage, the number of bedrooms, the number of bathrooms, the presence of the garage, the presence of a basement. They then compare that information to other properties in your area that have been rebuilt and now they have an estimated cost to rebuild.

Currently, my mortgage is around $140k and the insurance coverage provides somewhere in the range of $220k for rebuilding. Furthermore, the tax assessor values the property around $160k.

The assessment in many jurisdictions is unrelated to the value of the property, or the rebuild cost of the property. In one state near where I live they reassess every 3 years. Therefore a significant number of properties have not be reassessed since the price surge during COVID.

In the event that a disaster did occur which totaled the building, could I simply take the insurance payout to clear the debris and payoff my mortgage, then use whatever's leftover to buy a different house to live in? This would technically leave my current property's lot vacant, but without improvements I expect the taxes would be minimal and I could simply list it for someone that was interested in building their own house.

Lets run the numbers: the cost to rebuild is $220K but you want to only insure for the value of the mortgage plus the cost to clear the property. Lets assume it costs $10K to clear the property. And lets say that the insurance company does give you the $150K.

That means the money goes to the lender and the people that clear the land. Now you have nothing left but the land. So you sell it. You now have the cash from the sale of the land to pay for an apartment to rent, or the down payment for another house to buy

What you are missing is what you could have sold the property for before the fire. The difference between the sales price and the mortgage is your equity. Under your logic as long as the insurance payout covers the cost of the mortgage and the cost to clear the land then you are good. But what happens if the value of the property is many times the value of the mortgage , or even if there is no mortgage.

By not insuring to amount needed to get the house back the way it was, you have failed to protect your equity. The lender gets there money, so what was burned in the fire was your net-worth.