Options for living after a fire

Sam from Financial Samurai was kind enough to let me post on his site last month. I discussed the basics of home insurance. He also asked me what the living options are after a fire. What can I do with the insurance money? Do I have to rebuild? Can I just keep the insurance money to rent a house or buy a new home somewhere else? So I figured I would answer his questions in a quick post today.

Living after a fire

After the insurance payout for a total loss of my home, there were 4 paths I could take:

Option 1 – Rebuild on the old lot

Insurance will pay the cost to rebuild up to your coverage maximums. In our case that easily is over $1,000,000. So I could rebuild a brand new 3,200 square foot home on a half acre with a beautiful view. This sure beats the 20-year-old house that was there before.
The uncertainty of rebuilding is:
1) what will the cost be with contractors and supplies being in high demand. I will certainly have to pay out of pocket $100,000 to $200,000 to rebuild.
2) Do we even want to live back on the mountain and if we do not, what will the market be in 2-4 years when the home is built?
3) Will insurance continue to cover homes in our old neighborhood due to the recent fires and a similar fire in 1964?
One benefit of our street is that only 4 out of over 30 homes burned. This means most of our street is still standing. This adds value to our lot as there is a neighborhood. If I had a lot on a totally destroyed street I may rethink building.

Option 2- Rebuild on a new lot

Per California State Law, the insurance company has to pay for me to rebuild on another lot if that is what I choose to do. This is less appealing to me for the reasons above (costs and timeline). I do not see the benefit of trying to build if it is not on the same lot.
I do, however, know of one person doing this. They are rebuilding on a newly purchased lot because their old lot has benzene in the water, making it unlivable. Talk about a kick in the butt. First, your home burns down. Then you find out there is benzene in the water which may not be fixed for 2 more years. Brutal.

Option 3 – Buy a new home

Once again thank you California. Per California State Law the insurance company has to pay for a home of equivalent value if I decide to buy. Ideally, I would buy a home worth more than the one that burned down because the insurance payout will deduct the value of the land.
So if I am covered for a $500,000 for the dwelling, then I should buy a home in the $700,000 range so that insurance will count the land value (let’s say $200,000 – $300,000) and give me the rest of the money for the home.
The downside of this is that I would have to buy a home at today’s inflated home prices. Currently, there is a supply-demand since 5,000 homes went up in smoke and prices are 10-20% inflated. I would be paying more for an older home without a view as opposed to rebuilding.
In all of the scenarios above, I am still paying my old mortgage which is currently at 2.85% (year 2 of a 7-year arm). The mortgage does not disappear and likely would be transferred to the new home (whether it is built or bought). I do still get to keep my land which is currently valued at $450,000 but likely would sell at a deep discount today.

Option 4 – Take the insurance money and pay off the mortgage

Currently, the insurance company would not cover all of my mortgage, but I could theoretically take the coverage A and C monies and pay off the mortgage. Then I would be debt free, own the land which I would hold onto for 5 years or longer, and decide what to do. Maybe we would rent for a while or buy a smaller home in a different community.
Still financially speaking, living in a rental for 2 years while insurance pays it and building makes the most sense. Once the house is built we can decide if we want to move back in or sell it. Also in 2 years, we can decide if we want to buy or not because the insurance loss of use money will be gone.

What we decided to do

Well, we took paths 1 and 4. First I paid off my mortgage with the insurance money. It did not make sense for me to pay out over $1,000 in interest a month while figuring out my next steps. Then 3 months later I decided to build the home.
I did the math and by building, I actually get more of an insurance payout then if I do not build. Then, if we decide to sell, I figure we can make between $200,000 to $400,000 above what we bought it for in 2016 depending on the market. Hopefully, this educated gamble will pay off and we will be even further along on our financial independence path.

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