Extended warranties are, almost without exception, a bad deal for consumers. In fact, according to Consumer Reports:
“Retailers are pushing hard to get you to buy extended warranties, or service plans, because they’re cash cows. Stores keep 50 percent or more of what they charge for warranties. That’s much more than they can make selling actual products.”
Thus, while extended warranties were once reserved for high dollar purchases, many retailers have started pushing them for relatively minor items, as well. And why wouldn’t they? They’re practically printing money.
In most cases, however, you’re only paying for marginal coverage when you buy an extended warranty. Consider the case of a gadget with a one year manufacturer’s warranty. You can easily extend that to two years by using the right credit card.
Thus, the three year warranty that you’re being offered is essentially a bet that your purchase will break between 24-36 months after you purchase it. And guess what? Even if it happens, you can probably get something far better (and cheaper) by then.
So what’s a savvy shopper to do?
Create an “extended warranty fund”
Instead of buying warranty after warranty, why not create an “extended warranty fund.” In other words, whenever a retailer offers you an extended warranty, simply transfer that amount of money into a dedicated savings account*.
If/when problems arise, you can simply pay for the repairs (or replacement) out of your warranty fund. And once the fund builds up to a sufficiently healthy size, you can back off on your contributions.
There are two main benefits to self-insuring in this way. First, you’ll get to earn interest on the money as it accrues. Second, you’ll be the one that gets to keep the cash when your stuff doesn’t break.
Sure, there are bound to be some instances in which you would’ve been better off with the extended warranty, but remember… These warranties are designed to be profitable. Thus, more often than not, you’ll come out ahead by skipping them entirely.
*Note: Yes, I realize that this sounds suspiciously like an emergency fund. I prefer to make a distinction, though, as a broken TV doesn’t really constitute a true emergency, and thus shouldn’t be paid for out of your emergency fund.
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Statistically, the rate of failures for almost any product can be divided in three periods:
1. Early failures (e.g. material and assembly problems)
2. Random failures (no common cause)
3. Wear-out failures. (fatigue or depletion of materials)
Legal warranty normally covers the first period. There are normally few failures in the second period, relative to the first and third period. Extended warranties cover the random failures period.
See http://www.ideas-smart.com/extended-warranty-usually-worthless for more information.
I think this is a good idea.
And it can be used for a lot of things. Like paying extra for accident forgiveness or something like that. 9/10 if you set the extra money aside and save it or even invest it you will come out better.
Companies know this! That’s why they offer all of these gimmicks in the first place. They have already done the math. They wouldn’t give out these extended warranties if they weren’t making money off them.
I like to compare the extended warranty to health insurance, which I couldn’t risk being without!
there are certain things i think it is worth the extra expense for extended warranties, but most aren’t necessary worth it.
if paying buy credit card, also take a look at your credit card benefits. For example, masterassurance through mastercard will double the manufacturer’s warranty, gives price guarantee, accidental damage warranty, etc. certain amex cards also extend warranty.
This is so simple yet so brilliant. I would have to think that those who seem oppose do not fully understand the concept. This shows the inability of the average American consumer to “pay themselves.” They’re so used to paying others… they almost don’t want to stop! 🙂
http://www.getrichslowly.org/blog/2007/11/27/reader-tip-the-warranty-scam-buster-account/
It does sound a lot like an emergency fund, but if it keeps you from buying a worthless or semi worthless extended warranty, it’s well worth the effort.
Anything that lowers expenses, like warranties, and adds to savings, is worth doing no matter how it looks.
Good idea! Most warranties are full of holes anyway.
Just about every gold/platinum MC and Visa automatically double the maunfacturer warranty (up to a year added on) for free. As long as you pay it off monthly this is a decent free alternative to self-insurance. Or at least it gets the sales people to stop with their spiel.
I have a friend who claims he got a “free air conditioner” for his house under one of those home-warranty deals. I asked him how much he had paid in premiums to the warranty company over the years: of course totaling it up, he would’ve saved nearly $1000 by NOT having the home warranty and purchasing the air-conditioner outright.
A little thought exercise points out the obvious: the warranty companies always make money, even if they have to pay out — that is their business plan.
I never purchase extended warranties — normally if the item is defective it will fail during the original 1-2 year warranty period. If it fails after that period: that’s why I have a large emergency fund for repairs/replacements. Purchasing extended warranties on computers is insanity: why insure something that is obsolete in a couple of years, especially when the warranty is 30% of the original purchase price?
FYI: I only carry liability insurance on my cars as well.
MichaelK: Valid points. However, I’m a proponent of the view that you should only insure that which you cannot afford. Appliance/car repairs don’t fall into this category, and if they do, then I likewise can’t afford the extended warranty.
While it’s not an appliance, our cesspool requires maintenance every three years. It runs around $600. I have a weekly budget spreadsheet, and I do a 2-year projection, and this is an item that I budget for. I factor in inflation, and I usually come pretty close to the actual expense. This way, there are no surprises when the drains start to run slow.
I’ve never been a fan of extended warranties, but of the few I’ve chosen to purchase, most have been worthwhile, most notably for our washer and dryer. With a family of six, we go through a LOT of laundry, and I’ve had motors, agitators, and heating elements all replaced over the last several years. They’re old enough now that even the extended warranty has elapsed, so I won’t bother repairing them again. I have an “Appliance Replacement” account at ING that I’ve been putting $50 a month in for the past few years, so when it’s time to replace them, I’ll be ready.
Although I understand the concept behind “self insurance”, I think you are missing the point slightly. Insuring small ticket items (small electronics, appliances, etc.) is one thing, but the real benefit of insurance (warranties) is for covering the repairs of big ticket items. Lets take the ultimate in warranties: the auto warranty. Auto warranties are about peace of mind. I’d rather have predictible, small monthly payments of $20-$30 per month instead of a onetime hit of $2000. The money may be the same, but its the peace of mind it buys you.
Also, the profit the shops make on selling warranties is irrelevant. I’m sure shops make a killing repairing your broken car/tv/appliance as well.
So I do think treating warranties as purely a monetary transaction is not the point. Its the transferrence of risk and having a predictible model of expenses.
Jo: The only thing better than peace of mind is cheap peace of mind. 😉
I think this is a good idea; I never even thought of using this method to cover a potential “lemon.”
There’s nothing like peace of mind, eh. Thanks for the great tip!!!
I do this same thing with my insurance deductibles. I have higher deductibles on all my policies to keep the premiums down and I keep the money to cover those deductibles in an account that is separate from my EF.
I rarely buy extended warranties – that’s something typically reserved for major appliances and I will probably get one when I finally break down and purchase my first LCD television. I think self-insuring can be a good practice depending on the type of purchase. There are certain things (like Front-Load Washers and Televisions for example) that I won’t even try it with b/c they are extremely expensive to fix. Repair costs can easily exceed their value even when they are relatively new.
Maybe this post can lead you into another – one about how cheap things are made now. It seems like everything is just meant to be disposable now and if you get five years out of it then you’re doing well. My dishwasher is less than two years old and just started making the same sound a cat makes when you step on it’s tail… That’s probably not good. And this is coming on the heels of me replacing the hard drive in my 13 month old computer. It’s getting old.