Buying a Car Extended Warranty

July 14, 2009 by TFB

A family member asked me to help him buy an extended warranty for his car. I got the enviable job because the extended warranty costs a lot of money (over $1,000) and I have the reputation in the family for getting good value for money.

Is an extended warranty on a car "worth it"? The standard advice you hear about extended warranties is that they are not worth it. I disagree. I must say it depends. It depends on what price you pay and what you get for that price. The coverage is worth something. If you pay a low enough price for the right coverage, you can make the extended warranty "worth it."

Let me begin with what NOT to do when you buy an extended warranty.

1. Don't buy it from the dealership at the same time when you are buying a new car. New cars are covered by bumper-to-bumper manufacturer's warranty, typically for at least 3 years or 36,000 miles. The extended warranty kicks in only after the manufacturer's warranty runs out.

You have plenty of time to see how the car holds up while it's covered by the manufacturer's warranty. If it looks like it's rock solid, you don't have to buy an extended warranty. If after 2-1/2 years you think you are not going to keep the car for long, you don't have to buy an extended warranty. The extra time for making decisions and the opportunity for observation have value. Don't give up that value.

Also, when you are buying a new car, you get only one offer for the extended warranty. There's little chance to shop. You don't know if the dealership is offering the extended warranty at a fair price or not. If you buy the extended warranty together with your new car, chances are you will overpay by a lot.

2. Don't buy an extended warranty plan unless it's backed by the manufacturer and honored by all dealerships. There are extended warranty plans offered by third parties. I think the chances of getting a repair covered by the manufacturer is a lot higher than getting it covered by a 3rd party because the manufacturer is usually interested in building some loyalty from the owners. I have no scientific proof for this. It's just my opinion.

Most (all?) car manufacturers have their own extended warranty plans. They call them by different names, for example:

You just have to remember to shop for the extended warranty when your manufacturer's warranty is about to run out.

Now, how do you shop for an extended warranty if you decide to buy one?

3. Shop from any dealership, including out-of-state dealerships. All dealerships of the same manufacturer are authorized to sell the same extended warranty to all customers. The dealership is not on the hook for the warranty. The manufacturer is. You don't have to buy it from the same dealership where you bought your car. Your don't have to buy it from a dealership in your local area either.

Extended warranties have a high markup in the MSRP. Never pay MSRP. The markup on the extended warranty is pure profit because the dealership does not have to do anything to it until there's a sale. They just fill out some forms and collect the sales markup. If an out-of-state dealership has a willing customer calling them, ready to buy, they will much more likely offer a good price, because they know the customer is shopping for price and only a good price will get the sale. A quick sale for $100-200 profit is so easy.

4. Shop by phone, not online. Yes, the old fashioned telephone. You are unlikely to find really good deals online, because the manufacturer discourages posting discounted prices online. One "rouge" dealership ruins the fat profit for everybody. If you call and make an offer that still gives the dealership a reasonable profit, they will gladly accept the easy profit.

For the kind of extended warranty I was asked to shop for, I came to the conclusion that the cost to the dealership is 50% of MSRP. I got quotes for the same plan from three dealerships. Based on the 50% of MSRP number, here are their markups:

  Quote – 50% of MSRP
Dealership #1, local $700
Dealership #2, online $500
Dealership #3, out of state, by phone $200

You see the difference?

I sent my family member to dealership #3. Everybody is happy. He's happy to have peace of mind and he saved at least $300. The dealership got an easy $200 profit. All I've got is this blog post. :)

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Comments

8 Comments on Buying a Car Extended Warranty

  1. The Incidental Economist on July 14, 2009 | permalink
    2.  

    Can you extend your reasoning to address the following?

    1. The manufacturer knows more about the vehicle than any consumer does. Therefore, on average shouldn't the advantage be to the manufacturer? Shouldn't the price of the repair insurance (that's what it is) be higher than the expected cost of repairs?

    2. Having such insurance may motivate the holder to visit the dealer more often than (s)he would otherwise. Not all repairs are covered. Dealer repair costs are much higher than a non-deal repair shop. Won't this lead to higher repair bills for non-covered repairs? (Visit http://www.cartalk.com/content/mechx/ to find mechanics recommended by the Car Talk community.)

    Together, points 1 and 2 are what have always led me to ignore any thought of buying an extended warranty for a car. The only argument I can see for it being a good idea is if you know you have a crappy car. That is, you know you are a worse-than-average risk of using the repair insurance. I think if I were confident enough in that opinion I would try to sell my car and get a better one.

  2. TFB on July 14, 2009 | permalink
    3.  

    TIE – Thank you for your comments and questions.

    1. First of all, it wasn't my decision to buy an extended warranty. I was only asked to shop for one.

    2. Second, like any insurance, the insurer is expected to make money on average. That doesn't mean all insurance is bad for the insured. After all, we buy insurance all the time.

    3. This family member already uses the dealership for all services, even for oil changes. He's had multiple bad experiences with 3rd party shops and he's happy with the dealership's repair service. He thinks the predictable outcome and efficiency is worth the price he's paying.

    4. The specific extended warranty program I was asked to shop for covers everything except windshield wipers, battery, brake pads, and tires ("wearable" items). The cost differential on non-covered repairs is minimal.

  3. The Incidental Economist on July 14, 2009 | permalink
    4.  

    TFB, on your point no. 2, we agree that the insured pays a risk premium. On average that is a loss. What one is buying with the risk premium is protection from variation. What that is worth to an individual depends on that individual's risk aversion. I would argue that for the vast majority of people and for all but a few types of insurance, the risk premium is not worth it.

    For anything that could be financially catastrophic (loss of your home, severe health problem) it is sensible to pay the risk premium for most people.

    For some people loss of a vehicle through accident or collision is a large enough financial shock to warrant insurance.

    Vehicle repairs could be costly for some people, but the size of the population for which insuring for those makes sense has got to be smaller than for the foregoing types of events.

    Then there are less expensive appliances for which extended warranties are offered. These have got to be a bad value for almost everybody.

    My rule is that if I can afford to self-insure I do so. That leaves me only buying insurance for health, disability, life, home, auto collision/accident (newer vehicles only), and various forms of liability coverage. I've never bought an extended warranty and it is hard to imagine I ever will (I get some extended coverage for some purchases via my Am. Ex.).

  4. TFB on July 14, 2009 | permalink
    5.  

    The price has to be a crucial factor. It is conceivable that the manufacturer runs an underwriting loss while creating a profit opportunity to the dealers because doing so helps the manufacturer sell cars. The manufacturer does not have to make money from these on a stand-alone basis. If you cut down the dealer markup, you get closer to the true economic value. If you can buy a 100,000-mile extended warranty for $1, I'm confident you will buy it. If it's $100, it's still a good price. $5,000? Probably not. Therefore everybody must draw a line somewhere.

    Buying a warranty is not new. Whenever we buy a new car, we also buy a warranty. That warranty comes "free" but the price is built into the price of the car. I think the trend is increasing the warranty coverage, not cutting it and selling the car at a lower price. Some new cars also come with "free" maintenance for a few years. People buy new cars with free warranty and cars with free maintenance all the time. It's not irrational. People make decisions based on price and value received.

    Therefore I must say "it depends" when it comes to whether one should buy an extended warranty. The very first question is "at what price?" The next question is "what do you get?" Come think about it, it's not different from any other purchase decision, is it? Is a Honda Civic worth $X? Is a Ford Focus worth $Y? Are leather seats worth $Z?

  5. Arvind on July 15, 2009 | permalink
    6.  

    I've heard some extended warranties pay you most of the money back after the warranty period if you never use it. Anyone know if this is true? That's what a dealer told me once.

  6. Daddy Dub on July 15, 2009 | permalink
    7.  

    Came back to this again for a re-read and I like the caveat about "it depends". The answer to almost every question is that the devil is always in the details. But to categorically decide that warranties are good or bad is flawed logic. The correct answer, in my opinion, is to independently analyze any purchase or decision and use your best judgment.

  7. TFB on July 15, 2009 | permalink
    8.  

    @Arvind – I don't know the answer to your question. That must depend on the specific program rules.

  8. The Incidental Economist on July 17, 2009 | permalink
    9.  

    @TFB – I can see your point of view. (I'm not arguing with you just providing another point of view.)

    But I have another. A warranty is fundamentally different than most products other than an insurance product. You're transferring risk. Most other products don't involve risk transfer. Since the seller typically knows the distribution of risk better than the buyer the seller makes money on average. The premium, on average, is above the expected value of the coverage.

    Of course you may know your risk better than the seller. So you can win with insurance. But, on average you won't. On average you're better off self-insuring.

    Yet some cannot self insure for some risks (my prior comment).

    Some insurance is purchased with the hope you never need it. That's not true of most other consumer goods. Sounds like a riddle: what's something you buy but don't want to use? {Home, life, health, auto, disability, …} insurance.

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