Should you get a warranty? Know if Extended Warranties are Worth It

Should you get a warranty? If you are considering getting an extended warranty as you are planning on buying electronics or appliances for a family member this holiday season, then you have to read through this first. This contains a lot of information you may need about what extended warranty is all about.

Are Extended Warranties Worth it: All you Need to Know

What is Extended Warranty?

Extended warranties, sometimes called a service agreement, a service contract, or a maintenance agreement, is a prolonged warranty offered to consumers in addition to the standard warranty on new items.

Extended warranty may be offered by the warranty administrator, the retailer or the manufacturer. These types of warranties are provided for various products, but automobiles and electronics are common examples

Extended warranties that are purchased for multiple years, state in writing that during the first year, the consumer must still deal with the manufacturer in the occurrence of malfunction. Thus, what is often promoted as a five-year extended guarantee is actually only a four-year guarantee.

Extended warranties have terms and conditions which may not match the original terms and conditions. For example, these may not cover anything other than mechanical failure from normal usage.

How Extended Warranties Works

An extended warranty works like an insurance contract for the product you purchase and can be offered by either the product’s manufacturer or by the retailer, which contracts this service out to an insurance company.

What you should know is that, although the price of an extended warranty often seems like a bargain to a consumer who is aware of the steep price of repairs, it has actually been carefully considered through actuarial analysis by the company that offers it.

In other words, the company uses probability and statistical methods to calculate the likelihood that your new refrigerator or flat screen television, for example, will require repairs.

This figure is weighed against how much those repairs would cost to arrive at the price that a company will charge consumers for a warranty on a particular item. In aggregate, the company offering the policies is looking to come out ahead.

Probabilities and Profit Margins of Extended Warranties

Extended warranties, like the products they claim to protect, are sold to consumers for a profit and can be big money-makers for retailers. Often, profits from warranties will account for as much as 70% of a retailer’s operating income, compared to only 10% for the products they cover.

Probabilities and Profit Margins of Extended Warranties

What this means is that for every dollar you spend on an extended warranty from a retailer, $0.70 goes to the retailer, with the remaining $0.30 going to the insurance company.

This is because the insurance company also expects to profit from the agreement, it is clear that it doesn’t expect to have to make very many payouts.

Risk-Reward Ratio

The concept of weighing risk and reward is a key principle in investing: taking on more risk increases an investment’s possible return. The same is true for warranties.

According to the statistics from the Consumer Reports study, your washing machine has a 22% chance of needing repairs within the first three years, and your dryer is even more reliable, with only a 13% possibility that it will break down within that period.

If your appliance retailer (and its insurance company) is willing to bet on these odds, why should you not? Better yet, instead of handing your money over to the retailer, you could put the $660 aside in case your new purchase requires repairs down the road.

This way, not only will you get to collect interest on your own money, but you will also get to keep it if you beat out the odds and your appliances keep running as they should.

The Flip Side of Extended Warranties

Manufacturers and retailers tend to push warranties because they are profitable; however you need to decide for yourself whether the risk outweighs the reward; if a warranty gives you peace of mind, it may be worth the money.

Also, keep in mind that many products come with a standard manufacturer’s warranty free of charge. This warranty usually applies to the first year of the product’s life. This should be enough to cover you if your product turns out to be defective.

Furthermore, if you buy an extended warranty on top of this initial warranty, it will also start immediately, forcing you to pay a second time for coverage you already have. From the above therefore, if you still want an extended warranty, there are things you should consider.

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What to Consider when Getting an Extended Warranty

Always consider the replacement cost of the product you are buying, particularly when it comes to electronics. As these goods continue to improve and the prices continue to drop, your warranty could easily end up costing more than it would to replace the product when it fails.

Understand the manufacturer’s warranty before making a purchase. Federal law requires that you have access to the manufacturer’s warranty before you decide to buy. Note how long the warranty lasts, what it covers, and whether the company will refund your money.

Check to see whether you already have extended coverage through a credit card. If you bought the product using a credit card, check to see whether the card issuer extends the warranty. Many do for a period of one year or more.

If you are not sure whether your card provides such a perk, call customer service to find out. Or use an app like Sift, which will let you know before your make a purchase with a specific card how long the warranty will last.

Read the fine print. Extended warranty coverage may not be as comprehensive as you think. Extended warranties often include lots of exclusions that make the service less useful. The warranty may also require you to use a specific service provider or repair shop for service

In a Nutshell

Be that as it may, although warranties may seem like an act of customer service that companies extend to consumers, they are actually carefully calculated to be profitable for the companies that offer them.

In a Nutshell

As such, before you agree to insure your next big-ticket purchase against failure, carefully consider the likelihood that the product will fail, as well as how much it would cost for you to repair or replace it yourself.

In many cases, the odds will be in your favor and your best course of action will be to bet that your appliances and electronics will outlast the warranties you left behind.

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