It’s a really common mistake and one that can cost a homeowner a ton of money in the event of a total loss to their home. Homeowners across the country see their property values dropping and assume that it’s a good time to lower their home insurance coverage. The problem with this is that your insurance covers the replacement cost of your home NOT the market value.
The replacement cost and the market value of your home are two very different things. The market value of your home is the price it would sell for in the current real estate market and includes the value of the land that the home sits on. On the other hand, the replacement cost of your home only includes the structure of your home (no land) and is calculated based on current construction rates in your area (amongst other things).
This misconception is even more dangerous now because while home values have dropped significantly over the past few years, construction costs have increased. This has many homeowners believing they are adequately insured while they are actually under-insured.
How to estimate your insurance coverage:
1- For a rough estimate on how much dwelling coverage your home may need you can use an estimator such as this home insurance calculator. It will use average construction costs in your area and the square footage of your home to provide an approximate coverage for your home. This tool only provides an estimate on coverage and should not be used as a true figure when purchasing a policy.
2- For a more exact idea about how much dwelling coverage you need, you should talk to a licensed homeowners insurance agent. They will ask you about the various features of your home including building style, building materials, finished square footage, etc. to give you an estimated replacement value for your property.
3- Last but not least, make sure to review the coverage listed in your policy at least once a year or anytime you make any updates or significant renovations to your home. It’s important to do this as building costs can inflate and the replacement cost of your home may increase when you perform renovations and additions.
Source: http://homeinsurance.com/blog/2012/01/06/why-you-shouldnt-lower-your-home-insurance-coverage-when-your-home-value-drops/
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