How Much Cover is Enough Cover?

There’s never a “right” answer to questions like this. It always depends on your individual circumstances. But there are a number of guidelines to bear in mind. If you have a mortgage, the lender will usually give you a minimum figure. In most cases, this will be the purchase price you paid or the current appraised value. However, these are not the figures you need to rely on. Remember the lender is only interested in protecting the loan amount in the event that your home is reduced to ashes.

What are the issues? First off, you should not look at the amount you borrow. The key amount is the cost of rebuilding. Looking around the country right now, you see falling house prices. In part this is the end of a housing bubble. In part it is a feature of the credit crunch. Whatever the reason, the price of the land and what people are prepared to pay for the building on it are falling. But the cost of building materials and labor are increasing. Go back a few years and houses were appreciating assets. So you have to keep the amount of insurance up to date with the rebuilding costs, making sure that, should all else fail, you always have enough to pay off the amount outstanding on the loans you have secured on the property.

There are two kinds of homeowners insurance for this purpose. The first is replacement cost. This is a limited figure. If your house does burn down, you get the actual rebuilding costs up to this amount. The second is extended replacement cost. The premiums for this are slightly higher but it gives you a buffer to provide against the costs going up during the year. If inflation takes off, the number you fix at the beginning of the year may be out-of-date by the end of the year. The buffer usually allows up to 20% more than estimated building costs.

In all this, remember that it’s all down to you to get the rebuilding costs. No-one else is going to take responsibility for you. So think about it. Your mortgage is essentially going to be the same liability. The amount you have specified as the cost of rebuilding is the maximum amount payable (unless you have extended cover). If you have done your sums right, the house will be rebuilt and the lender will be happy. But if you’ve underestimated the cost of rebuilding, you may not be allowed to start the rebuilding work unless you can guarantee the shortfall out of your own savings. That means you may have a forced sale of the land with the insurance paying off the mortgage and nowhere to live. Do it right every time you renew or else you may pay a big penalty.