Homeowners insurance reimburses you when your property or belongings are damaged by a covered disaster. Your payout can vary significantly based on whether you have actual cash value vs. replacement cost coverage.

The key difference between the two coverage types is that actual cash value (ACV) insures your property for replacement cost minus depreciation, while replacement cost value (RCV) covers the full cost of replacing destroyed or damaged property.

Suppose your home furniture is destroyed in a fire. Replacing it with similar furniture would cost you $5,000. But due to age, wear and tear, and the furniture’s life expectancy, your insurance adjuster estimates it was worth only $3,000 at the time of the fire.

• If you had replacement cost coverage: Your insurer would reimburse you $5,000, based on the cost of replacing the furniture, minus your deductible.

• If you had actual cash value coverage: Your insurer would reimburse you $3,000, based on what the furniture was worth at the time of the loss, minus your deductible.

Not surprisingly, insuring your property for its replacement cost value offers more financial protection when you’re shopping for home insurance. However, you’ll pay higher premiums for replacement cost coverage. Let’s break down how actual cash value vs. replacement cost value works when you file a home insurance claim.

What is actual cash value coverage?

Actual cash value coverage is a type of insurance policy that uses the depreciated value of your home or personal property to calculate how much your claim is worth. With an ACV policy, your insurance company accounts for factors like age and the condition of the property when the covered peril occurred to determine how much you’re reimbursed. Your reimbursement is the market value of the property, minus your home insurance deductible.

Insurance policies where ACV is common

Always check your policy documents to determine what type of coverage you have. That said, here are some policies where actual cash value is the norm:

• Personal property coverage in home insurance: The personal property coverage part of your home insurance policy covers your personal belongings, like your jewelry, electronics, furniture, and clothing. Usually, personal property insurance is ACV coverage. However, some insurance companies give you the option of insuring your belongings at RCV.

• Renters insurance: A renters insurance policy covers your personal belongings, while your landlord’s insurance covers damage to the home’s structure. You’ll often be able to choose between ACV vs. RCV when you buy a renters insurance policy.

• Car insurance: Most auto insurance policies use ACV to determine your reimbursement if your car is damaged, totaled, or stolen. Because cars depreciate rapidly in the first few years, this puts you at risk of being upside-down in your loan when you finance a new car. Some buyers purchase gap insurance to help pay the difference if their car is totaled while they owe more than the vehicle’s ACV.

What is replacement cost coverage?

Replacement cost coverage insures you for the full cost of replacing your home or personal property without accounting for depreciation. This type of coverage often applies to the dwelling coverage part of your home insurance, which protects your physical home and attached structures. Most standard home insurance policies have dwelling coverage limits equal to the home’s replacement cost value.

There are a few types of RCV coverage:

• Standard replacement cost coverage: Your insurance provider would pay the full cost of replacing your home and property up to the policy limits. For instance, if your home was destroyed and your dwelling coverage limit was $300,000, your insurance company would pay out up to $300,000. But if the full cost of repairing or replacing your home was $315,000, you’d have to pay the remaining $15,000 out of pocket.

• Extended replacement cost coverage: This type of coverage is purchased as an endorsement, or add-on, that boosts your policy limits by 10% to 50% if damage from a covered loss exceeds your dwelling coverage limits. So if you had dwelling coverage of $300,000 and a 30% extended replacement rider, your policy would pay up to $390,000 toward rebuilding your home.

• Guaranteed replacement cost coverage: Your policy pays the full cost of rebuilding or repairing the property if you purchase a guaranteed replacement cost endorsement. If your dwelling coverage limit is $300,000 but it will cost $400,000 to replace your home due to higher building costs, your insurer would pay the full replacement cost. If you purchase this endorsement, you may need to notify your insurance company if you make a home improvement that exceeds a certain dollar value.

Some insurers won’t allow policyholders who own an older home to buy a replacement cost policy. Instead, they might offer what's known as a modified replacement cost policy. With this type of policy, your insurance company would pay for repairs using modern construction materials and techniques instead of replacing materials like hardwood floors that are common in older homes.

Read more: What does homeowners insurance cover? And what doesn't it cover?

Actual cash value vs. replacement cost: Which is better and how to choose

To compare the differences between actual cash value vs. replacement cost value, let’s look at a hypothetical example. Suppose a tree crashes through your roof and causes $20,000 worth of damage. But the roof is five years old, so your adjuster determines that its actual cash value was $15,000.

Here’s how your payout would break down if you had replacement cost coverage vs. actual cash value coverage, assuming a $1,000 deductible.

As you can see, your out-of-pocket expenses are significantly higher when you have actual cash value coverage vs. replacement cost coverage. The trade-off, though, is that your insurance premiums are likely higher with RCV coverage.

The cost of rebuilding a home or making major repairs after a catastrophe could be enormous, particularly when you consider that the costs of labor and materials tend to rise over time. For that reason, it’s usually wise to purchase standard replacement cost dwelling coverage at a minimum.

It’s also worth getting insurance quotes for extended replacement coverage and guaranteed replacement coverage endorsements. Speak to an insurance agent about what levels of coverage are appropriate for your situation.

While you’re at it, compare the costs of ACV vs. RCV for your personal property coverage. If you have ACV coverage, upgrading to RCV coverage for your belongings may be relatively inexpensive, often less than $50 extra per year.

Read more: How much homeowners insurance do you need?

FAQ

How do insurers determine actual cash value?

Insurers calculate actual cash value by determining the cost of replacing a fixture or item, then subtracting how much it’s dropped in value due to depreciation factors, like age and the condition at the time of the loss. Your insurer may also look at the cost of replacing similar items in your area.

Which is better, actual cash value or replacement cost value?

Replacement cost value coverage is better in the sense that it provides more financial protection. Your claim will be paid based on what it costs to restore your home to its original condition or fully replace a destroyed or stolen item. However, actual cash value coverage is usually cheaper than replacement cost value coverage.

Do insurance companies pay RCV or ACV?

For dwelling coverage, which insures your physical home, most policies use RCV, or replacement cost value, to determine your payout. Actual cash value, or ACV, is the norm for the personal property part of most home insurance policies, though you’ll often be able to upgrade to RCV coverage. If you’re not sure what your home insurance covers, check your policy documents and contact an insurance agent if you still have questions.