Actual cash value vs replacement cost

Mandy Sleight
Mandy Sleight

Setting a limit for your homeowners or renters insurance policy is fairly straightforward. However, deciding between actual cash value vs. replacement cost reimbursement isn’t always as easy.

For most people with renters or homeowners insurance, replacement cost insurance coverage is the most advantageous if you need to file a major claim. However, this coverage comes at a cost – one that might not be worth it for every individual. We’ll help you understand the differences between actual cash value and replacement cost so that you can weigh the pros and cons for yourself.

What Is Actual Cash Value Coverage?

Actual cash value is an item’s fair market value at the time that you file a claim. This value is determined by taking the cost of buying a new item (also known as its replacement cost) and subtracting depreciation. The longer you’ve owned an item, the lower its actual cash value.

Let’s use a TV as an example. If you purchase a brand new model for $400, you won’t be able to sell it for the same $400 two years later. The most someone will pay for a used TV after two years of wear and tear might be just $300. This depreciated market price is what insurance companies try to estimate when calculating an item’s actual value.

There are both pros and cons to choosing actual cash value coverage. The advantage is that your premiums will be lower, which is helpful if you’re hoping to save money on your monthly bills. On the other hand, you’ll get less money from the insurance company in the event of a covered claim.

How Does Actual Cash Value Work?

To calculate an item’s actual cash value, the insurance company first needs to determine its estimated lifespan — the number of years you would typically be able to use it before you needed to buy a new one. When you file a claim, the age of the damaged items, how much it would cost to replace, and the salvage value of the item is used to determine its actual value. The older an item is, generally, the less it’s worth, and the less you’ll get reimbursed for that item.

For example, let’s say you purchased a TV five years ago for $600. Based on the actual cost calculation, the insurance company determines its current value is only $100. Instead of receiving the replacement cost to purchase a similar new TV, you’ll receive $100 towards another TV. If you want a similar TV, you’ll have to pay the difference, unless you have opted for replacement cost value in your insurance policy.

What Is Replacement Cost Coverage?

Unlike actual cash value coverage, replacement cost value policies don’t use depreciation when determining how much your belongings are worth. If you file a claim, your insurer will provide you with the funds to replace each item with a new equivalent. In most cases, this amount remains the same regardless of how long you own the item.

With replacement cost coverage, a $400 TV will be reimbursed at its full amount even if you’ve already owned it for a couple of years when you file a claim. (Keep in mind, though, that your deductible will still be subtracted from the total amount you receive.)

Replacement cost insurance coverage may pay out higher claim amounts, but it also costs more than actual cost value coverage. You’ll have to weigh this tradeoff when purchasing your policy.

How Does Replacement Cost Work?

When you submit a claim to your insurance company for an item’s replacement value, the adjuster will research its market value based on the description you provide. This is why it’s important to be extremely detailed when creating a home inventory for your homeowners or renters insurance.

If you simply list a 50-inch TV, for example, then the insurance company may only pay for the least expensive model that fits this vague description. Try to provide as many details as possible, such as the item’s defining characteristics and a list of any special features. Including documentation, such as a serial number and receipt showing the original purchase price, is the best way to ensure you’re fairly reimbursed.

Guaranteed vs. Extended Homeowners Insurance Replacement Cost

There are many different ways to calculate homeowners insurance replacement costs depending on the type of coverage. Under the dwelling portion of your policy, your insurer may let you upgrade to guaranteed or extended replacement cost coverage. Both of these options are designed to help rebuild your home in the event of a total loss if construction costs exceed your policy limit.

With extended replacement cost coverage, your insurer will give you a cushion up to a certain amount above what your dwelling is insured for, usually around 25%. For example, if you have $200,000 in dwelling coverage and end up needing more funds to rebuild your home to its previous specifications, extended replacement cost coverage will pay up to $250,000. Once you’ve exceeded this limit, however, you might have to either pay out of pocket or build a smaller home.

If you select guaranteed replacement cost coverage, you won’t face a set limit should you need to rebuild your home. While this may seem like an unlikely scenario, it’s more common than you might think, often occurring after a natural disaster destroys many homes in the same area. If large numbers of homeowners need to rebuild at once, this may drive up the cost of materials and labor far more than 25% above their usual price.

Actual Cash Value vs. Replacement Cost, Which One Should I Get?

Replacement cost vs actual cash value is largely a personal decision based on your preference for short term vs long term financial protection. If you have the choice of replacement cost insurance vs actual value on the dwelling, replacement cost is usually the preferred choice for financial protection, as it allows you to restore your home with new items without the need to come out-of-pocket for the depreciated value of damaged items. If you are on a tighter monthly budget or are not planning to live in the home for an extended period of time, actual value might be more cost-effective. Should you choose to renew your policy, you may be able to switch to ACV or RCV, depending on what is best for your circumstances.

Actual cash valueNo added cost
Policies may be cheaper overall
Depreciated value on claims
May not be able to replace items for ACV cost
Possible higher out-of-pocket costs for item replacement
Replacement costUsually automatically applied to dwelling coverage
Optional addition for personal property
Replacement cost reimbursement, not depreciated value
May come with additional cost
May require providing documentation to prove original value of items when filing claim

The Bottom Line

Deciding between actual cash value vs. replacement cost coverage is just as important as setting the limits on your homeowners or renters insurance policy. The type of coverage you choose can have an enormous effect on how much money you receive from your insurance company if a devastating loss ruins your personal property. After learning about what is actual cash value coverage, it may be worth it to pay extra for replacement cost coverage. If you end up deciding on actual cash value coverage, consider keeping a bit of extra cash in your emergency fund to cover the depreciation that your insurer won’t reimburse.

About the Authors

Mandy Sleight is an insurance writer for Over the last three years, she has covered insurance providers, coverage, costs of insurance, and more at MoneyGeek, Bankrate, and The Simple Dollar.