The average 2,000 square foot home in the United States is an existing home which has a market value of approximately $134,000. Like four out of five U.S. homebuyers, your buyer may have just purchased an older home, but when it comes to insuring that home, is market value going to be enough?

Market value and replacement value aren't the same thing, caution insurance industry analysts. This misconception often begins with the first time home buyer whose first experience with homeowner's insurance is when the lender asks for a year's homeowner's liability insurance to be placed in escrow before closing. Typically, the figure used for this amount is based on the market value or selling price of the home. But should disaster strike, these homeowners will be shocked to learn that rebuilding and replacement costs far exceed the insured amount.

Why? Current market value is based on existing comparables of other like homes in the area, and doesn't include the value of your buyer's personal belongings. As you know, comparables are a general figure - they don't list individual features unless they are extraordinary. You have no way of knowing whether the home that sold for the same price down the street had the same, better or worse features as your buyer's home unless you saw them for yourself.

The market value also takes into account the age and condition of the home which cannot be duplicated should parts of the home need replacing. Your buyer can only replace with materials and labor costs as they exist in your area. For those reasons, the market value may also be considerably less than replacement value.

Your buyer also needs to know that for insurance purposes, insurers view an older home differently than new construction and for good reason. The odds of a fire, leak or flood are greater in an older home.

"The condition of the home is very broad depending on the insurance company, but they will be very particular about the maintenance, upkeep, heating, cooling, wiring, and plumbing," says Bryan Freeman, assistant vice president of underwriting for State Farm. "If I were buying the home, I would want to know it had been well cared for. The insurance company will be looking at that when they decide whether they want to insure the home. Some companies adjust the premium according to the age of the furnace, and wiring and even plumbing - a new phenomenon, but you can't argue with the logic. The older the furnace, the higher the possibility it will cause a fire, and the older the plumbing the higher the probability of a water leak."

In purchasing an older home, your buyer probably paid less per square foot than new homes in the same area. In 1997, the median price of a newly constructed home was $145,000, as opposed to the median price of an existing home at $124,100.

New construction is higher in price even including the fact that it often offers the advantage of lower priced materials which can be bought in bulk at better prices. The large national builders particularly use their size to advantage to build more features and more square footage for less than comparable local custom builders.

But in the event of a disaster, it will be a local remodeler, not a national builder, who will tear out and replace damaged areas of your buyer's home. This small to medium business owner works on a project-by-project basis, and is unable to match the resources of a large new construction company. Add to the higher costs of materials and labor the additional costs of tear out and clean up and your buyer's replacement costs are as much as double the price of a comparable new home.

You can help your buyer by letting them know that the insurance premiums that are set aside at escrow should be re-evaluated before they move into the home or shortly thereafter. Your buyer can get an replacement estimate from a local contractor as well as from the insurer and compare.

Understanding the difference between market value and replacement value can make the difference in whether your buyer will be able to rebuild in the event of a disaster.

Published: August 3, 1998

Use of this article without permission is a violation of federal copyright laws.

Blanche is a renowned author of five real estate books. Her newest, Bubbles, Booms and Busts: Make Money In Any Real Estate Market, McGraw-Hill, was rave-reviewed by The New York Times. She was also selected from hundreds of real estate experts to contribute to Donald Trump's book, Trump: The Best Real Estate Advice I Ever Received: 100 Top Experts Share Their Strategies, Rutledge Hill Press, and is featured on page 68. Order Now Review - Honors In 2006, Blanche was selected among scores of candidates to author two consumer real estate guidebooks for the National Association of Realtors: The NAR Guide to Home Buying, and The NAR Guide to Home Selling, Wiley & Sons. She is currently planning two new books for the NAR and its members.       Known for her keen insight into real estate industry issues and for her ability to make complex subjects easy to understand, Blanche is a sought-after keynote and continuing education speaker. Real estate organizations from MLSs, to brokerages, to franchisors, to associations hire her to provide up-to-the-minute analysis of real estate industry news and advice on how to improve revenues. Her passionate delivery, peppered with stinging wit, is a huge hit with audiences and fans. Don Klein, CEO Greater Nashville Association of Realtors, Blanche Evans, Richard Courtney, president 2007, GRAR "The GNAR membership meeting last week featured Blanche Evans as the keynote speaker. Her comments and insights resonated extremely well with those in attendance and we have had many requests for copies of her PowerPoint Presentation. She was a terrific part of the membership meeting and convention program!" - Don Klein, CEO Greater Nashville Association of Realtors Coverage from WSMV, Nashville - 8-14-2007 That Interview Guy - Get Inside The Head Of Today's Generation 2007 AE Institute Session - To purchase 2006 AE Institute Session - Parts 1 2 3 4 5 6 7 8 9 HouseValues Mastermind call - Parts 1 2 Blanche's fireside chat with Jeremy Conaway, HAR - Click here. For more articles by Blanche, click here.