An old adage holds that the multimillion dollar casinos in Las Vegas weren’t built on the profits of winning gamblers.
The same rationale, say consumer experts, may hold true with regard to buying extended product warranties.
“If manufacturers were losing money with extended warranties, do you think they would be selling them?” asked Tod Marks, senior projects editor at Consumer Reports.
For the most part, extended warranties remain an ill-advised purchase in most circumstances. But, like so many things financial, there’s no one-size-fits-all answer. Here are some ideas to help you decide whether an extended warranty is, in fact, a sensible buy.
Warranties and profitability
Extended warranties, which can also go by the label of “service contracts,” are designed to provide maintenance or repair of products beyond what’s addressed with warranties that are part of the purchase price. Merchants of all sorts have been dangling extended warranties for years, covering everything from a $100 cell phone to a $100,000 automobile.
While the length of extended warranties will differ significantly — Marks said the average term is between three and four years — one thing that’s consistent across the board is their profitability. A recent report by the Institute for Operations Research and the Management Sciences found some extended warranties have profit margins in excess of 200 percent.
“Keep in mind that warranties really make a profit for the retailer,” said Michael Levin, associate professor of marketing at Otterbein University in Westerville, Ohio. “Usually the retailer is selling the warranty and not the manufacturer, which also means you have to use that retailer and not that manufacturer.”
Another issue is that extended warranties frequently go unused. A poll conducted several years ago by the consumers group Angie's List found that 61 percent of Angie’s List members had purchased some sort of an extended warranty, but half who did so said they never actually used it.
“You’re betting that the item will break after the warranty that’s included has expired and during the time period when the extended warranty is in place,” Marks said. “The likelihood of all that is incredibly narrow.”
Another potential issue is a warranty that doesn’t make financial sense even though the coverage is fully in effect. A $150 repair on a broken clothes washer may seem a nice expense to avoid, but it becomes a good deal less so when it’s covered by an extended warranty that carried a $200 price tag.
Do your homework
Whether an extended warranty is a good buy — a rare occurrence, consumer advocates insist — can boil down to as much advanced research as possible before making a decision. First on the list is a complete understanding of the length and terms of the warranty that’s included with the purchase. In many cases, that may be solid enough to make an extended warranty moot or suggest further research to find a similar product with a better warranty.
“Confirm the length of the manufacturer's warranty. Manufacturer warranties are designed to ensure your purchase functions as promised when you take it home and use it,” said Roger Beahm of the Center for Retail Innovation at the Wake Forest University School of Business.
Next, research a product’s life expectancy. Search the Internet and see what other people have encountered with respect to the expected length of the product life.
“Consider the brand itself. Different brands often mean different quality,” added Beahm. “Does the brand have a reputation of reliability? This is key when considering the need for an extended warranty; often buying a higher-quality brand without an extended warranty is better than buying a cheaper brand with an extended warranty.”
Think about your own habits as well. Are you likely to keep and use a certain item for a lengthy period of time, or do you look to replace it every couple of years or so?
“If you are looking for a $99 digital camera, you'll want to think about how long that item will be used,” Levin said. “If you think you'll really only use the item for six months or a year, buying a two-year extended warranty doesn't make sense."
If an extended warranty appeals for whatever reason, know precisely what it covers. For example, the manufacturer's warranty on a new car may last for several years — or a certain amount of mileage — and cover every working part of the vehicle. An extended warranty may extend the original warranty but offer much more limited parts and service coverage.
Extended warranty alternatives
The allure of an extended warranty is understandable — the peace of mind of knowing that if something breaks, someone or something has your back.
That said, it’s important to remember that there are options other than extended warranties that can afford that sort of protection. First is shopping for and selecting reliable products. Services such as Consumer Reports and other sites offer extensive information on product durability, so hedge your bets by buying something that’s likely to last.
Another idea is to set up a “rainy day” fund. Here, you set money aside on a regular basis to cover any possible repairs — or, if something is seriously out of whack, a replacement.
If you used a credit card to buy a product, investigate any applicable warranty coverage offered through the card. All four major cards — Visa, MasterCard, Discover and American Express — offer extended warranties for products purchased with their cards. In some cases, that can tack on an extra year of warranty protection at no additional charge.
Check with your state consumer affairs division about a law known as “applied warrant of merchantability.” While specifics will differ from one state to another, almost every consumer product you buy comes with an implied warranty of merchantability. This is a form of guarantee that a new item will work if you use it in a reasonable manner. You can ask the merchant who sold you the product for a replacement or refund; if that doesn’t work, talk with a lawyer.
Finally, give some thought to the product itself. A car costing tens of thousands of dollars which you plan to drive for the next 10 years or more is a significant investment. A plastic-encased camera that ran you less than $100 is undeniably a more dispensable item, one where “protection” really isn’t an issue at all.
“For some, the absolute price of the item may be so low that it may almost be considered a disposable item rather than a durable good,” Beahm said. “When that's the case, it may not be worth the hassle of exercising a warranty if and when the product stops working. Simply dispose of it and get a new one.”