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Extended Warranties: When They Actually Make Sense

When should you steer clear of an extended warranty? Read on.

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Richard Lowe typically doesn’t buy an extended warranty when he purchases a product. However, when he plunked down almost $700 for a robotic vacuum cleaner in 2015, he concluded that paying $85 for an extended warranty was a good idea, because the relatively new technology had multiple moving parts.

It turns out that he made the right decision. The robotic vacuum cleaner broke almost exactly 1 year later, just as the salesperson suggested that it very well might do. Lowe walked into a Best Buy with his broken floor-care appliance and walked out with a new robotic vacuum cleaner.

This is the best-case scenario for a consumer. Lowe’s extended warranty ensured that his robot would be replaced at no additional cost to him if it broke after its original warranty expired. Consumers often face a decision on whether they should add an extended warranty to their purchase, and the decision typically has to be made quickly at the point of sale.

It seems that consumers generally are skeptical when it comes to buying an extended warranty. Seventy percent of people are unwilling to buy one, mostly because they don’t believe that the extended warranty is worth the money that they pay for one in the long run, according to a survey by The Warranty Group, which provides extended-warranty services to manufacturers and retailers. Your decision on whether it’s a good idea for you to purchase one depends on whether you can afford to repair or replace an item if it’s broken and how dependent that you are on the product, according to the 12 experts whom we interviewed who have experience on both sides of the extended-warranty business.

THE NITTY GRITTY. Extended warranties are like insurance: You pay for something that you might never use, says Matt Pinsker, who is a lawyer and adjunct professor at Virginia Commonwealth University. “Companies offer extended warranties, because it is more likely they will get more money selling them than they will have to pay out in claims.”

Extended warranties can be purchased through a one-time payment or, increasingly, through monthly installments that seem to lower your pain at the register. Our research found that extended warranties typically are underwritten by small insurance companies that are owned by major insurance companies. (For example, AppleCare is serviced by Illinois National Insurance, which is a subsidiary of AIG. First Colonial, which underwrites automobile extended warranties, is a subsidiary of Allstate Insurance.) Retailers receive a commission when they sell an extended warranty.

Salespeople persuade shoppers to purchase an extended warranty by saying that it saves them money if the product were to fail and they wanted to repair or replace it. What salespeople don’t tell consumers is how much money that companies make when they sell that peace of mind to the customer. They also don’t tell you that the chances are that you might not need it. “[Extended warranties] bring in more money [at an automobile dealership] than the Sirius department, the parts department and the sales department,” says Roberto Fabris, who is a 30-year veteran of automotive business development and marketing. “It’s the profit center of the dealership.”

Extended warranties provide a revenue double dip for companies that underwrite them. The companies not only earn commissions, but they also reap the profits after those commissions are invested. “A lot of our income comes from the ability to invest those monies [from extended-warranty purchases] in U.S. stocks,” says Doug Timmerman, who is the president of Ally Financial, which underwrites extended warranties for automobiles. In other words, companies benefit tremendously when consumers are convinced that they should buy an extended warranty.

Repairs are at the heart of the extended warranty. Consumers often don’t know until after a product fails what exactly their extended warranty covers, how they can get the product fixed and how much money that the extended-warranty provider is willing to spend to fix the problem. The cost of the repairs is important, because most extended warranties limit what will be paid to repair a product. For example, our research found that you could purchase a used vehicle for $6,000 and spend $2,500 for an extended warranty that has a $3,000 repair limit. If, say, the engine were to fail and repairs cost $3,500, then you’d have to pay $500 out of pocket to get the repair.

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