About "Extended Warranties" For New & Used Vehicles

An "extended warranty" is, in actuality, a service contract. And service contracts, a.k.a. extended warranties, have replaced life and income insurance as most sellers' favorite trinkets. Why? Because they can be sold to customers who pay cash as well as customers who finance. In addition, they are much more profitable than life and income insurance because, unlike real insurance, the prices of service contracts aren't regulated by state insurance commissioners.

How profitable are service contracts?

Let’s look at how the potential profit of insurance compares to that of service contracts. An insurance provider, for instance, might sell you life and income insurance that costs $2,000 over the course of your loan. The provider's maximum profit on that sale is generally limited to "only" 55 percent of the insurance's gross cost. That would be $1,100 in our $2,000 example.

Service contracts can cost thousands, too. But guess what an average service contract costs the average dealer in claims? Under $100. The rest of the sales price is pure profit. Let's see: if a seller charges you $2,000 for a service agreement, that makes the seller's typical profit $1,900 on the sale of the service contract. Nice.

New car service contracts

Another reason that profits on service contracts/extended warranties are high is that coverage is generally limited. For instance, if you read the average policy for a new vehicle carefully, you'll find a version of this language: "though we say this is a five-year contract, this policy doesn't go into effect until your car's regular warranty expires in three years." This limitation means you're in reality paying a fortune for a two-year warranty, not a five-year.

Many dealers get rich on these service agreements for another reason. Rather than sell you a national service agreement such as one offered by GMAC, they sell you a questionable agreement from one of a number of no-name companies located in states with few consumer protection laws. Why? The dealers generally own the companies.

So should you buy a service agreement, or extended warranty, for a new vehicle? Unless you are absolutely sure you're going to keep a vehicle for years beyond the manufacturer's warranty, service contracts on new vehicles are a waste of money for most people. This is particularly true as manufacturers have extended the length of their warranties.

If you decide you still want a service agreement, then insist on a contract from a national manufacturer or company (one with a track record for honoring the warranties) and negotiate that price down to $450 to $500. If you are financing through a credit union or bank that can't sell you a manufacturer's service contract (such as GM or Ford, etc.), then make sure that the warranty company is a reputable national company. Generally speaking, banks and credit unions use reputable companies.

Used-car service contracts

If you are buying a used car from a dealership—whether in person or online—(before you even think about an extended warranty), negotiate a proper free warranty before you sign anything but after you have agreed on a price for the vehicle. If you insist on a good free warranty before agreeing on the vehicle's price, you'll probably (and secretly) be stuck with a "service pack." For instance, if you insist on a 100%, 90-day drive-train warranty before you agree on price, your seller will be happy to provide it but will probably charge a higher price for the car to cover the potential risk of repairs.

To give you an example, the seller will sell you a $4,000 car for $4,400 and bank the extra $400 as "insurance" against future repairs. Since the seller has neglected to tell you he's raised the price, he is covered on both ends. If the car needs repairs, you have paid for them in advance; and if the car doesn't need repairs, he has an extra $400 profit. So before you even think about a service contract, get a free warranty properly negotiated and agreed to.

That said, for a used vehicle a good, nationally-recognized used-car service agreement bought cheaply enough can be a very smart idea, if you plan to keep the vehicle for years. Just remember that the service agreement should supplement the seller's own warranty not replace it.

In all likelihood, the seller will tell you the service contract is a duplication of warranty and will not be inclined to provide his own protection. Don’t accept that answer. If the seller's warranty does duplicate your service agreement, the seller will be protected. But if problems should develop that are not covered by the service agreement, you may still be protected.

So how can you locate a good used-vehicle service agreement? Those sold by credit unions and banks are usually relatively good. Used vehicle warranties underwritten by the major auto manufacturers are usually good. But the used service agreement is dominated by fly-by-night companies, and many dealerships sell the fly-by-night variety. Stay with brand names, and pay attention to other lending institutions that use the same warranty company. For instance, if the particular service agreement on offer isn't also sold by a local bank or credit union, I would avoid it. Finally, don't pay more for an agreement on a used vehicle than you'd pay for one on a new vehicle. Try to bargain the price down under $450-$500.

Buying a service contract directly

A number of online companies now offer car owners the opportunity to buy a service agreement, or extended warranty, directly. Although these can be a good idea, particularly for used vehicles, do your homework in checking out the company and apply the same criteria as you would in buying through a dealership or financial institution: national, reputable, proven track record. Also remember that it may be harder to negotiate a price online, though the quoted prices will typically be lower than those quoted by dealerships.