An extended warranty is available for purchase when you buy certain products such as consumer electronics and automobiles. It adds additional warranty protection either from the time of purchase or after the manufacturer’s warranty expires. While having an extended warranty to use when something you buys breaks or stops working is nice, the cost can be very significant. Is the cost of an extended warranty worth the added protection?
Calculate the Cost to Benefit Ratio
There are thousands of products you could buy an extended warranty on, so I can’t tell you whether or not your specific product deserves an extended warranty. However, the easiest way to determine whether or not you should buy extra warranty coverage comes down to calculating the cost to benefit ratio of the coverage.
The calculation is made up of 4 major parts:
1. The Likelihood You’ll Need the Coverage
Do you plan to use this item in environments where it is likely to sustain significant damage to the point that it needs replacement? Is the product known to break after a short time of use? Or is it a great item made by a great manufacturer, but you just plan to use it heavily every single day and increase the wear and tear on the item?
2. The Cost of the Item Being Covered
Warranties are like insurance. You only need it when you need to file a claim, and at some point the cost of replacing the item on your own becomes insignificant. If you feel like you need to buy a warranty on a $100 item, you probably shouldn’t be buying the item in the first place because $100 is pretty insignificant.
3. The Cost of the Extended Warranty
The cost of the warranty obviously plays a significant piece in the equation. You might consider insuring that $100 item if the warranty cost you $1. Then again you need to heavily consider if a $1,700 Macbook Pro deserves a $350 AppleCare Protection Plan. (That’s about 20% in extra warranty cost on top of the laptop’s price.)
4. What Coverage the Warranty Provides
You need to know whether or not the warranty is even worth having. Are the rules and stipulations so tough to meet that you will essentially be throwing money away on the coverage because you will never use it? Or are the descriptions of when you qualify for a claim clear, understandable, and most importantly realistic? If you can never legitimately file a claim then the warranty is useless.
Types of Extended Warranty to Avoid
There are three types of extended warranty products you should avoid. Step away if…
…the warranty is prohibitively expensive
There is a line where buying the extended coverage just doesn’t make sense. It might be 25% of the item’s price for one person and 33% for the next person. But paying too much for coverage just doesn’t make sense.
…the warranty provides a low cost to benefit ratio
You get a low cost to benefit ratio two ways: buying an expensive extended warranty you can expect to use and buying any extended warranty that is so complicated you won’t be able to file a claim. If the benefit isn’t worth the cost — or any cost — walk away.
…the warranty duplicates coverage from the manufacturer or your credit card
Most items you buy come with a minimum 1 year manufacturers warranty. Yes, it might be more complicated to file a claim, but it is included in the price of the item. Some manufacturer warranties are even longer, so know what your item has before making a purchase decision.
Even if your manufacturer’s warranty is only a year, many great credit cards offer free warranty extensions of their own. You need to know your specific credit card’s perks well, but this warranty is extension comes at no cost if 100% of the purchase price goes on the credit card (rather than paying some on the card and some with cash or a gift card). If you get this additional coverage you may not need to purchase extended warranty coverage at all.
Some Real Life Examples
I want to share with you some real life examples. In general, I always turn down extended warranty offer with the following two exceptions.
Home Warranty Service
I don’t buy individual warranty on any home appliance. However, I do buy a home warranty service which costs me about $45 a month. With this service, all the major appliances, central air conditioning system, heating system, hot water system, plumbing system, and electrical system are covered. In the two years that I subscribed to this service, I have saved more money than I paid for the warranty.
If you have a fairly old home with aging systems and appliances, this is a great warranty to purchase to give you a little peace of mind. Another side benefit is that the company guarantees the work of its contractors, so you do not have to worry about dealing with shady contractors who may overcharge or do bad work.
Another thing that I do is have a separate savings account to self-insure my purchases. Instead of buying the extended warranty, I put that amount into this special savings account. For example, instead of spending $350 on the AppleCare Protection Plan, I add $350 to the savings account. I give up the option of exercising my extended warranty coverage for the guaranteed money in the bank that I can use for repair or buy a replacement. So far, I am well ahead of the game using this strategy.
Image by soxophone player via Flickr.
Kevin Mulligan is a debt reduction champion with a passion for teaching people how to budget and stay out of debt. He’s building a personal finance freelance writing career and has written for RothIRA.com, Discover Bank, and many others.