Service Contracts & Extended Warrantees

by Gary Foreman

John and Mary had just about picked out the television they wanted. They had often thought that it would be nice to have one in their bedroom so they could 'snuggle up' while they watched the late news.

When they had selected a model, they headed for the counter to pay for the set. Just as Mary pulled out her credit card the salesperson struck. "So I suppose you'll want the extended warranty on this baby."

Ah, that little question that concludes so many purchases we make. But without batting an eye both John and Mary both answered "No!". They hadn't hesitated or consulted each other before answering. How could both of them be so sure that 'no' was the right answer?

It's funny. Most of us take some time to make a major purchase decision. Whether it's a TV, microwave oven or a new car we'll probably do a little shopping. Maybe check out a buying guide for repair records and 'best buys'. Even do a little negotiating with the sales staff to get a better price. But then we make a snap decision on a service contract with very little but our 'best guess' to help us.

Let's begin by defining what a service contract is. They are typically offered on home appliances, electronic products and automobiles. The contract is an agreement to pay to repair a specific item for a specific period of time. It may cover some or all of the parts and labor. The contract may begin when you purchase the item or some time later (often when the manufacturer's warranty expires). Some service contracts may be purchased even years after an item is in use.

One thing that's important to remember is that you're buying insurance. That means three things. First, you only want to insure yourself for losses that you can't reasonably afford to pay yourself. So you probably don't need an extended warranty for a low cost item. Most family budgets can handle $100 or even $200 losses every so often. A $1,000 repair bill on a big screen TV or your car may be a different issue.

The second thing is that insurance companies sell insurance to make money. They will need to charge enough so that on average they can afford to pay for losses and commissions to salespeople and still have some money left for profit. Some reports indicate that stores can make as much money on selling service contracts as they do on the sale of the appliance itself. Stores have been known to pay as little as 20 cents for repairs for each dollar of insurance sold. No wonder they try so hard to sell them!

You're also counting on the insurer being able to pay when you incur the expense. You wouldn't buy fire insurance on your home from a company that might not be there when your house burns down. The same should hold true for an extended warranty. Know who's behind the promise to pay.

OK, now that we know the basics. What steps should we follow before deciding to buy a service contract? Begin with the product you're buying. Make sure you've chosen a product with a good record for reliability. Check out the warranty that's offered free by the manufacturer. You should include these steps as part of any purchase you're making anyway.

Then consider what would happen if the item needed repair the day after the manufacturer's warranty expired. If it's a piece of lower cost audio equipment and breaks after 3 years it might not be a big deal to just buy a new one.

If it's a bigger item ask yourself 'what's the worst thing that can happen?'. Say you need to replace your car's engine in five years. Depending on the car you're facing a $1,500 to $2,500 bill. If the service contract adds $1,000 to the cost of the car today (and you're making car payments) you'll actually pay in the area of $1,500 over the life of the car loan because of interest. You might be better off taking the extra money that you'd pay each month on your car loan and use it to start an emergency fund.

Next you'll want to check what the contract covers. Don't take the salesman's word on coverage. Chances are that many salespeople have never read the contract that they're asking you to buy. Find out specifically what is and isn't covered. Are repairs caused by routine use covered? What about unsatisfactory maintenance? Does that void the warranty? Look to see how the contract defines normal use and other terms.

Are both parts and labor covered? What about repair sites? Can you take it to any shop and be reimbursed? For larger items is a service call to your home included? What about if you move out of state? Do you have to return the item to your old state for a covered repair?

Yes, I know that it's a hassle to try to read all that fine print with a salesperson looking over your shoulder. That's probably why they make it so small to begin with! You can actually use this to your advantage. Once you've nearly decided on your purchase ask the salesman for a copy of the service contract to take home to review. That will give you ample time to review it properly. It will also give you a little extra time to make sure that the purchase itself is wise. If they don't want to let you take a copy of the contract I'd wonder how good it really was.

You also need to decide if now is the only time to buy the contract. If you really want an extended warranty you'll probably be able to buy it in a year or two. You might have to shop a bit to find the right insurer, but don't believe it if you're told that 'you have to buy it now or not at all'.

Like other forms of insurance it pays to compare policies. Some credit card companies are offering extended warrantees if you purchase an item on their card. There are also independent companies offering coverage.

Finally, if you'd like more information there are brochures available from the government. If you send your name, address, item numbers and fee to "R. Woods, Consumer Information Center, Pueblo, Col. 81009" you can receive publications about service contracts. "What Consumers Should Know About Service Contracts and Repair Services" by the Electronic Industries Association, item 586Z is free. "Auto Service Contracts" by the Federal Trade Commission, item 402Z, costs 50 cents.

Should you buy a service contract with your next major purchase? Well, no one can answer that question for you. Only you know all the circumstances surrounding your finances and the purchase. But before you fork over your hard earned dollars for a service contract just remember to review all the facts. That's the best way to stretch your budget!

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Gary Foreman

Gary Foreman is a former financial planner and purchasing manager who founded The Dollar website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money and Gary shares his philosophy of money here. You can follow Gary on Twitter or visit Gary Foreman on Google+. Gary is also available for audio, video or print interviews. For more info see his media page.

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