Extended Warranties: For Most of Us, They're a Waste of Money
Sales of extended warranties have seen between 15 percent and 20 percent annual growth over the past 3 years. And there's good reason for retailers to push them: Extended warranties are mostly just a high-margin upsell for the companies that provide them. And in almost every case, they are a bad deal for consumers.
Why Extended Warranties Get Such a Bad Rap
Extended warranties are a form of insurance -- which makes them, at bottom, nothing more than a bet against "the house."
"Insurance companies [and extended warranties] only make money if the company collects more money than it pays out," says Professor Bruce Clark of Northeastern University's D'Amore-McKim School of Business. Companies that offer insurance and extended warranties have teams of actuaries who calculate the odds that a consumer will file a claim. And the odds aren't in our favor.
It's this entirely accurate impression that we're gambling in a rigged game to buy them that gives extended warranties their bad rap. It's hard to visualize the benefits until you use any form of insurance, and even when you have it, you hope to never need to use it.
A Good Buy for Klutzy People
Whether or not you should consider extended warranties might be better based on the type of person you are than the types of products you're buying. Are you klutzy? Prone to breaking things? Do you have unusual usage habits for your gear? Then extended warranties may actually be a good fit for you.
"A friend of mine bought smartphones for himself and his teenage son, but he only bought the insurance for his son," says Clark. Think about it in the context of your car, for example, he suggests. "If you are an unusually heavy user, for example, driving twice as much as the average person, then an extended warranty based on time [not miles] may make sense."
Most of us aren't klutzes, and the way we use our technology is fairly close to the norm. That makes us the type of consumers companies want to sell extended warranties, to because we're unlikely to make claims.
When Even You Should Buy a Warranty
While it doesn't make financial sense to buy an extended warranty or insurance on a $30 toaster, are there other purchases where it is actually a good idea?
"We advise consumers to consider: 'What would my life be like not having this device and what would the cost if I wanted to replace that particular unit be?' " says Stephen Ebbett, president of ProtectYourBubble.com. "So if your TV was to break outside of the manufacturer's warranty, that could be a $3,000 bill or more."
Ebbett also recommended that consumers think about what it would be like to be without a critical item or gadget in their life. For example, if you were to loose or break your smartphone, what would that be like?
The obvious items that you may want to buy an extended warranty for are laptops, smart phones, and tablets. You may also want to consider an extended warranty for an expensive camera like a digital SLR.
How to Avoid Falling for the Extended Warranty Trap
One of the best moves you can make is to say "no" at the register when a cashier offers you an extended warranty. But there are a few things you can do if you're nervous about an item breaking.
First, review the existing manufacturer's warranty. You may be able to file most claims directly through the manufacturer if you have any issues with an item. It pays to understand the coverage that comes with most products -- its limits, exclusions, and when the coverage expires.
Manufacturer's warranties cover most repairs that you might need. You should also understand that many manufacturers' warranties cover you through the expected useful life of that item. If it breaks, that's most likely an indication that the product wasn't built to last much longer anyway, and you simply need a new one.
"Just about all manufacturers warranty their purchases for a certain length of time (most do so for the first year) and many credit cards will extend that warranty. In some cases, they double it," says David Bakke, writer from the popular blog Money Crashers. "A few instances where it might make sense to purchase an extended warranty are for used automobiles and older homes. For all other purchases, invest in a quality brand name and you also lessen the chance that your item will break down."
If you feel like you have to buy an extended warranty, shop around for the best deals. Don't get trapped in thinking that you have to buy the warranty where you buy the gadget. You may find a better deal -- more coverage, fewer restrictions, faster returns, and better service -- from a third-party insurer.
Consider Self-Insuring Your Purchases
You can also consider self-insuring your purchase. If you are worried about how you'd pay to repair or replace a specific broken item, each month, set aside a small fraction of its cost in a savings account. That will give you a fair amount of assurance that you when it comes time to replace it, you'll be in a good position to do so. And you never need to worry about having wasted your money if it outlasts your self-warranty.
For example, if you're buying a brand new refrigerator, look up the expected life span of that model online. Typically, people need to replace refrigerators every 10 years.
So, if a refrigerator costs $2,000 and you are worried about it breaking, set aside $17 a month. And, in 10 years, you'll have enough saved for a new one. Of course, this is a simplistic example, but it gives you an idea of how to think of self-insuring your purchases instead of buying an extended warranty for them.
Most consumers should skip extended warranties almost all the time. Even when they seem relatively cheap, they're rarely worth the money, because the odds are you won't use them.
Do you routinely purchase extended warranties? Why do you like buying them? Are there certain types of products where you always buy an extended warranty?
Hank Coleman is a financial planner and the publisher of the popular personal finance blog Money Q&A, where he answers readers' tough money questions. Follow him on Twitter @MoneyQandA.