The truth about extended warranties, and what to do instead

Published June 13, 2016   Posted in How to Think

Buy a car, a cell phone or virtually anything expensive, and we usually don’t walk out the door without first being hit up for an extended service plan, or warranty. These warranties are sold as a way to “protect our investments”, but do they really work?

Pinterest: You don't need an extended warrantyThe truth is these extended warranties often do nothing more than serve as a healthy source of commission for your salesperson. Darn near 50% of the cost of warranties are kept by the retailer. The margins are sky high, more or less extra profit for very little risk shouldered by the business.

And think about it – a business exists to make money. By very definition, these extended warranties help the business far more than they help the consumer. They are a product, just like whatever we just bought, and no business offers consumers a product at a loss. For the large majority of us, extended warranties are bad investments, and corporations are well aware of that fact.

The reason is simple – the majority of us never use the coverage that we paid for, as Consumer Reports wrote, calling warranties an “expensive gamble”.

A recent Consumer Reports survey found that 55 percent of owners who purchased an extended warranty hadn’t used it for repairs during the lifetime of the policy, even though the median price paid for the coverage was just over $1,200. And, on average, those who did use it spent hundreds more for the coverage than they saved in repair costs.

Extended warrantiesFor a warranty to be worth it, three things must occur:

  1. Something needs to happen (a failure, broken equipment, etc) that is covered
    1. Warranties have very specific coverage events and stipulations
    2. Warranties have dates where coverage is appropriate
  2. We need to actually use the warranty that we paid for during the repairs
  3. The cost of the repairs needs to exceed the price that we paid for the warranty

The fact is that warranties are big business. Case in point – I made the mistake of buying a brand new Cadillac CTS back in 2010. Several years ago, my manufacturer warranty expired, and to this day, I still get phone calls from third party companies attempting to sell me on a warranty. Nearly four years later, businesses remain steadfastly interested in “protecting my investment” for a hefty fee that they know I probably will never use.

According to Warranty Week, Americans spent nearly $15 billion on automotive warranties in 2013. In the same year, another $7 billion was spent on computer-related warranties and over $5 billion for coverage on electronics. In total, Americans shelled out almost $38 billion for extended warranties and service plans. When I say big business, I really do mean big business.

A quick word about exceptions – Naturally, there are times when extended warranties do come in handy. A Google search will reveal instances where warranties do indeed save consumers money. I get it, it happens. Hell, a Harvard Business Review post attacks the Consumer Reports survey by citing intangible benefits of warranties, like the peace of mind we may get by the warranty’s protection. The author also provides a story about when his laptop suddenly stopped working shortly after purchase, making the repair costs nil.

But the data on this subject makes the author’s argument entirely unconvincing on the whole.

On average, the majority of us will demonstrably lose money on this proposition nearly every time, which accounts for why most businesses hard-sell warranties and extended service plans. They understand that most of us simply won’t use them. After all, there’s a reason why companies pay call centers to sell consumers on warranties, even well after the purchase. For the business, on average, it’s a bet against the consumer that they usually win.

But what about those times when things do go wrong and we wished that we bought an extended warranty? How do we hedge our bets against these kinds of expenses, but minimize spending money on something that we probably will never use? After all, things do happen. Stuff breaks.

If we don’t shell out for extended warranties, what do we do then?

A better approach for extended warranties

Instead of buying warranties, consider setting money aside – perhaps in an interest-bearing savings account, to provide resources for any unforeseen expenses related to our more expensive purchases – in essence, setting up our own warranty coverage. This way, WE have full control over this money and can re-purpose those funds, as necessary, if we sell the item without needing to use this money.

According to the numbers, this strategy will work in your favor much more than it won’t. Essentially, we are betting that we’ll spend less money in the long run compared with buying a warranty, and I’d take these odds in Vegas any day of the week.

How much should we set aside? Consider setting aside the cost of the warranty.  If you bought a $600 cell phone (ugh!) and were hard-sold on a $100 warranty, then put $100 aside. Or, if an extended warranty for your car costs around $500 a year (which is around the average), then put $500 a year aside in a savings account. Your money will grow (albeit slowly), and chances are you’ll never use it.

And even if we do need to use the money, we also aren’t filling out any paperwork, submitting receipts and waiting for weeks for reimbursement, or fighting with the company over something that we thought was covered but wasn’t. A headache and a half – every time.

By the way, your emergency fund can work the same way depending on how liberally you interpret an “emergency” in your life to be. Keep your own warranty coverage in an easily-accessible account that you control rather than depending on a for-profit company, who depends on you to NOT use your warranty coverage, to protect your stuff for you.

Because in the end, the company will protect itself first and you second.

And that’s something you can bet on!

MONEY SAVING TIP: Credit cards very often provide warranties on the things that you buy with that card. Investigate your credit card’s perks to avoid purchasing redundant warranties even if you believe the warranty is worth the cost.

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Comments

26 responses to “The truth about extended warranties, and what to do instead”

  1. I think folks will be much better off putting money aside in an emergency fund than buying a warranty plan. That said, my 5 year old tv started to show signs of dying just this week. Half the screen still has color and the other half is fading to black and white. Perhaps planned obsolescence…

  2. Good point. Back when I still rolled with a $600 iPhone I paid $100 for the warranty. Then one day kayaking the phone went overboard into the river, never to be seen again. The warranty didn’t cover lost phones now I was out $700 rather than $600. These days my phone’s cost as much as I paid for that stupid warranty.

  3. Arrgo says:

    I bought a new car 2 years ago and they offered me an extended warranty for $1700 with a $200 deductible. This extended the bumper to bumper warranty from 60K to 100K miles. (My car already comes with 100k mile powertrain coverage etc.) I’m thinking i’m out $1900 before they will pay for anything. Certainly wasnt a good deal and I declined it. In most cases I’d rather take my chances and keep that money in my own pocket. The odds are definitely in the insurance companies favor or they wouldnt be doing it.

  4. Apathy Ends says:

    I worked retail for a year in college, we would get in trouble if we didn’t pitch the warranty when selling tools or appliances. It’s shocking how many people actually buy them.

    Most of the time it was elderly women buying gifts that would pay an extra 5-8% for the warranty – even less of a chance they get used if it’s a gift

    • Steve says:

      Yup, me too. I worked at a camera shop in high school and the extended service plans were our largest sources of commission, BY FAR. Funny how that works. 🙂

  5. Mr. PIE says:

    The best warranty we ever purchased was for our dining room furniture. We purchased Scotchguard application to protect our furniture from stains. What did this do? We had an incident where juice from over exuberant slicing into a haggis while celebrating Burns night ( yes, you read that right- haggis) splattered all over the seats of our dining room chairs. A fountain of juice spewed from the knifed haggis. The stain could not be removed by our considerable efforts or the cleaning company from the furniture store. We got brand new chairs for the princely sum of about $70 for the Scotchguard warranty.
    Of course, if you are like most folks, avoid eating haggis and this type of caper can be avoided.
    Kind of ironic it was SCOTCH guard that protected us from the haggis fiasco……

    • Steve says:

      Wow! Yeah, that is an interesting scenario – can’t say I’ve heard about anything quite like that before, though. But hey, the at least the warranty worked for ya that time! 🙂

  6. I never never never buy them! Even on cars. Once, I was offered an extended warranty on a $9 rain poncho at a sporting goods store! What idiot buys these?!

  7. I’ve never bought an extended warranty. I kept the money and put as much as I could into my portfolio. Over the years, I’ve watched the portfolio grow into multiple millions. Warranties will never grow!

  8. Mr. SSC says:

    We don’t do extended warranties for all the reasons mentioned above. We were tempted to get one on our refrigerator when we first got it because it was a big purchase, and we hadn’t made many of those yet at that point, but after running the numbers we decided we’d gamble and not get it. 8 years later it is still running well, although I probably just jinxed it, and no warranty was used. The same with out first big TV purchase, Mrs. SSC was debating the extended warranty, and then realized our credit card covered it for the same amount of time, so hooray for credit card coverage!
    My FIL recently bought a new Subaru Outback with all the technology available and he got the extended warranty mainly because it covered the elctronics for another few years. Since it has adaptive cruise control and 16 other radar like gadgets running in it, he figures it’s peace of mind if/when one of them breaks, because they are not cheap to replace!
    On a related note, I also still get calls for my Camaro on extending the warranty and I haven’t owned it for 3 years now. So annoying.

    • Steve says:

      Good on you for not getting screwed over with a warranty. I had thought about just telling them that I no longer own my CTS the next time that someone tries to sell me on a warranty, but looks like even THAT won’t work. 🙂

  9. Ken says:

    I remember a time about 10 years ago when a major UK electrical retailer nearly went under, profit on sales was way down and they were facing bankruptcy, all that kept them afloat was the profits from the extended warranties and they are still wit us today. Enough said!

  10. Yep, very few warranties are worthwhile. Liz Weston did a good piece for either her site or MSN Money a few years back about which ones are worth it.

    One of the few I’ll buy is a Best Buy computer warranty. We do have to use those for repairs sometimes. My computer’s screen died about a month after the manufacturer’s warranty pooped out, and we’ve needed tech support two or three times since I got the damn thing.

    • Steve says:

      Yeah, computers can definitely be a crap shoot. Sometimes warranties work, sometimes they don’t. I don’t buy warranties on computers either, but I can see where they might become worth it for a lot of people!

  11. Morgan says:

    I couldn’t agree with you more. Businesses are, above all else, working for money. It’s important to be mindful of the ways warranties work and what they actually cover. Setting extra money aside to take care of emergencies when they strike is a really great suggestion; you’ll certainly be glad you have that fund if an accident ever ensues! Nice points you make here! Thanks so much for giving your insight!

  12. Carrie says:

    A friend of mine was unlucky enough to have both her fridge and chest freezer die within a few days of each other. She went to an appliance store and purchased both a new fridge and chest freezer. She mentioned to the sales women that her manager would be happy that she made such a big sale. The sales women was honest with my friend and said “my manager won’t think I did a good job at all because I didn’t sell you the extended warranty.

    • Steve says:

      Wow, that puts things into perspective, doesn’t it? It’s not enough to just sell appliances. You gotta sell those high-margin warranties, too. 🙁

  13. Trenton says:

    Buying a warranty can be a gamble. I recently began opting out of extended warranties on my smartphones and laptops. This can be risky with technology but I found a local repair shop that would fix my devices cheaper than what the warranty would cost me. Thanks for sharing.

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