An Extended warranty, sometimes called a service contract, is a prolonged warranty that extends beyond the warranty of the product. They may be offered by the manufacturer or a third party.
For example, when you buy some electronics online or in-store, you may be asked whether you would like to extend the warranty by paying a little more; when you buy a used car, some car dealers may offer an extended warranty over that car.
Are extended warranties good deals?
How Do Extended Warranties Work?
Extended warranties extend the warranty bundled with the good or service. For example, you purchased a phone and the manufacturer sold the phone with a 1-year “limited” warranty. During this 1-year period, if the phone breaks due to defection (“workmanship”), the manufacturer will pay for repair cost.
At the time of the purchase or near the end of the original warranty, the manufacturer or a third party may offer to extend the warranty for three more years. This means that, after the end of the first year and before the end of the fourth year, this extended warranty will cover the repair cost under certain conditions.
Purchasing Extended Warranties in Most Cases Is Not a Good Idea
Economically speaking, extended warranties work exactly like insurance: The provider charges a cost upfront and pays for the uncertain event of repairing. Just like other types of insurance, on average, the provider makes money by selling the extended warranty, and the consumer on average loses money by purchasing the extended warranty.
The basic principle of purchasing an insurance product is to only insure against events that may cause financial hardship, since those financial losses can be devastating and too difficult to recover from. However, most extended warranties only help prevent minor financial loss. Therefore, in most cases, purchasing extended warranties loses money on average and doesn’t protect from financial hardship.
When Is Purchasing an Extended Warranty a Good Idea?
Since, economically, an extended warranty works like an insurance policy, the principle of purchasing an extended warranty is not much different from that of an insurance policy: Buy the extended warranty only if it prevents financial hardship.
For example, if repairing a car causes financial hardship for you, it may be a good idea to purchase a good extended warranty for your car. When your car breaks down, the extended warranty can truly protect you from financial hardship.
Conclusion
Extended warranties extend the warranty bundled with the original product. In most cases, purchasing extended warranties is not a good idea because the consumer loses money on average and it doesn’t protect from financial hardship. However, it may be a good idea to purchase the extended warranty if it prevents financial hardship.