The Money Question: Are Extended Warranties a Rip-Off?
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The Money Question: Are Extended Warranties a Rip-Off?

Are extended warranties on electronics and appliances a rip-off or smart money move?
Linda Sherry

Q. Whenever I buy electronics or an appliance, I'm asked if I want an extended warranty. I always say no. But a friend just had his laptop fixed for free, and another got a new stove. So are these warranties a rip-off or not?

A. Buying an extended warranty is a bit like gambling. The company is betting the device won't break during the coverage period; you're betting it will. And though some people walk away from a roulette table with a jackpot, nobody would say that gambling is a smart investment. With rare exceptions, the house wins. The same goes for extended warranties (a.k.a. service contracts), especially since they may not cover wear and tear, only product defects.

That doesn't mean, however, that buying one is always a bad idea -- only that you're right to be skeptical. Most products come "preloaded" with a warranty of up to a year (and, by the way, you rarely have to register the product to get the coverage, but you will need a receipt). And if a product is going to break, it tends to do so in the first few months. Before you pop for the extra coverage, ask yourself a few questions.

Would it cost a lot to replace?

Like insurance, extended warranties protect you from budget-busting emergencies. But there's little point in protecting gadgets that aren't that expensive to replace -- a $200 cell phone, for example, or even a $400 tablet computer. If it breaks prematurely, buying a new one would be a drag but it wouldn't bankrupt you. Buying a warranty you'll never use for every new gadget, on the other hand, could add up to a lot of wasted money. So save the warranties for high-priced items, like your kid's computer.

What's the cost ratio?

Because only a tiny percentage of customers ever make claims, extended warranties are big moneymakers for the companies selling them. A juicy commission goes to that salesperson giving you the hard sell (perhaps as much as 50 percent of the total price), then administrative costs and profits come out of the remainder before a small chunk actually goes into funding payouts to customers. To weed out overpriced plans, compare the fee for a year of warranty coverage to the cost of the product it's protecting. If it's more than 10 percent of the price, walk away.

Who's offering the program?

Find out who's backing the warranty. It could be the retailer, the manufacturer, or a third party. Manufacturer-backed plans are the surest bets. They're the most likely to still be in business if you ever need to collect, they tend to offer the best terms and conditions on their plans, and they generally have the best customer service -- not to mention the expertise to resolve problems with their own products.

Are you already covered?

Put the purchase on plastic since many credit card companies provide free extended warranty coverage to their customers. An Amex, Visa, or MasterCard from any issuer will generally double the length of the manufacturer's warranty for electronics and other gadgets, up to a maximum of one additional year. Confirm this policy with your credit card companies before you shop.

What are the details?

You'd need a team of attorneys to decipher the fine print in a typical extended warranty. So before biting, find out some key information, either by checking with the salesperson or, better, by holding off on a decision until you can call the program's toll-free number. Skip any plan that makes you buy the warranty on the spot. Questions to ask: Is two-way shipping to the repair facility (or in-home service) provided at no extra cost? Can you get a loaner during the repair process? Will the product be replaced for free if repair isn't feasible? If the answer to any of these questions is no -- or if you can't get a clear answer -- take a pass. Instead, check the manufacturer repair ratings with Consumer Reports ($30 for a one-year digital subscription) and put the money you'll save on the warranty toward a higher-rated brand.

Linda Sherry is a director at Consumer Action, a national nonprofit advocacy group based in San Francisco. A specialist in personal finance, she has been a frequent guest on CNBC and National Public Radio and an expert witness for Congress.

Originally published in Ladies' Home Journal, June 2012.