Understanding Extended Warranties: An Insider’s Guide

Understanding Extended Warranties: An Insider’s Guide

If you're like most people, you've been getting a lot of phone calls lately warning you that your car's warranty is about to expire, and telling you to buy an extended warranty to keep your coverage going. The Federal Trade Commission has a specific warning about extended warranty cold calls advising you to stay away because most of them are outright scams - and by the way, they don’t actually know the status of your factory warranty; they’re lying about that.

You can read more about extended warranty scam calls and what to do about them here.

But the sales pitches might make people wonder if an extended warranty from a more legitimate company is for them. So here, without further ado, is the Car Talk Extended Warranty Insider’s Guide.

Vehicle Service Contracts and Warranties - What Are They?

First, what exactly is an extended warranty? That's a question that has several answers, and to really get into it, it’s helpful to define some terms. A warranty is just a guarantee that the company issuing the warranty will repair or replace a product if it breaks during the warranty period. To be a true warranty, it needs to be included in the purchase price.

When you buy a new car, it comes with several warranties, like bumper-to-bumper and powertrain. You don’t have to pay anything for them - they’re rolled into the price of the car. If something that’s covered by the warranty breaks, all you have to do is get the car to the dealership for a free repair. Usually those warranties last from 3 to 5 years and 30 to 60,000 miles, whichever comes first.

That doesn’t mean you’re fully covered for anything that breaks. Wear items like brake pads, clutches, and headlight bulbs are usually excluded from coverage. And you usually have to do some things if you want to keep the warranty in place. You’ll need to have regular maintenance performed on the car - things like oil and filter changes, and anything else the owner’s manual says should be done at specific mileage or times.

Federal law says you don’t have to get it serviced at the dealership to keep your warranty, unless the dealership services your car for free, but you should be able to show receipts either from the shop you take it to, or from the parts store if you do the work yourself.

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When is a Warranty Not a Warranty?

Often when you buy that new car, the dealership will offer you the chance to buy an extended warranty. You pay extra to get extra coverage, usually extending both the time and mileage your car is covered. But many extended warranties aren’t really warranties at all. Remember, to be a real one, a warranty can’t cost extra. If you have to pay for it, it’s really a service contract.

That’s an important difference, because service contracts often have features that aren’t part of true warranties. You not only have to pay extra to get them, but you might have to pay a deductible any time you use them. Plus, service contracts don’t necessarily cover everything the factory warranty did, which means even if you have one, you might still be on the hook for the full cost of a repair. And, most service contracts don’t start any coverage until the factory warranty has expired. So if your factory warranty is 4 years, that 5 year extended warranty really only covers you for a year.

Throughout this article, we’ll refer to extended warranties and service contracts interchangeably, but remember that extended warranties are not actual warranties.

Cartalk warranty periods infographic

Certified Pre-Owned: Is it a Warranty or a Service Contract?

On the used car side of things, this process gets even more complicated. Service contracts like the ones sold for new cars are often available from the used car dealership, and they work in basically the same way. But many used cars are part of a “Certified Pre Owned,” or CPO program. That’s where a dealership’s service department inspects a used car - usually one that’s already in good condition - and performs any work that’s needed to bring it up to standards set by the car’s manufacturer. That gets it a CPO designation.

CPO cars come with an extended warranty that’s backed by the manufacturer. Because it’s included as part of the CPO purchase price, it’s a real warranty. But there’s a pitfall you have to watch for - some used car dealerships have “certified” cars that, well, aren’t really CPO cars.

To be real, a car’s certification and warranty have to be backed by the factory. If they’re not, then “certified” means whatever the dealership says it does and you need to find out exactly what that is before you buy. Often it just means they’re charging you more for the same car.

A good hint that a certified car isn’t genuine is if you’re buying it from a dealership that doesn’t sell new cars of the same brand. So that “certified” used Honda isn’t a factory-backed CPO car if it’s not at a Honda dealership. Bottom line, if you’re considering a certified used vehicle, ask if it’s a factory-backed program and, as always, read the fine print before you sign anything.

All of that only covers what dealerships have to offer, but if you already own your car and are shopping for a service contract, you’ll most likely end up with a 3rd-party contract, and that’s what we’re going to concentrate on from here out.

How to Choose the Best Provider for Your Auto Service Contract

Let’s say Car Talk listener Steve buys a used Lexus that’s about 5 years old. He pays $40,000 for it and wants to minimize repair bills, so he starts shopping for a service contract. He does a quick internet search and finds several companies selling them, but how to choose the right one? He starts to research customer reviews of the companies he’s looking at, and settles on a few that have generally positive feedback.

What Steve doesn’t realize is that the companies he is finding are actually three different types of companies...

Cartalk warranty marketing infographic

Marketers

But what Steve doesn’t know is that oftentimes the company selling a service contract isn’t the company actually providing it. The names he’s finding, names like Carshield, AutoPOM!, or Carchex, are marketers. They sell service contracts on behalf of other companies.

Sometimes those companies need to register with any state they sell contracts in, but oftentimes they don’t. If you buy a service contract through a company that only markets them, after you sign, it will get sent to a company called the Administrator. For a number of reasons, including that the rules governing companies that only sell contracts can sometimes be more lax than those which Administrators must follow, it’s always a good idea to know which company administers your plan.

Administrators

The service contract agreement Steve ends up signing is with an administration company that is often completely separate from the company he bought the contract from. Administration companies, such as Omega, Royal, or Integrity, are the businesses that actually handle the execution of the extended warranty. And it’s that company Steve really needs to check out, because the administration company is what he’ll have to deal with if he ever needs to use the plan.

Administration companies often have to get a registration or a license from any state they provide contracts in. There are a number of laws and rules they have to follow, and those can be different depending on what state the extended warranty is issued in. After you read this article, we’ve compiled a state-by-state law summary to give you an overview of what regulations companies have to follow in your state.

The administration company is the outfit you’ll deal with any time you need to make a claim on your extended warranty. They’re the ones that actually issued the contract. You’ll want to concentrate a lot of your research on the company that will administer any contract you’re thinking of signing, as that’s the company that will control how well the extended warranty covers your vehicle.

Insurance Underwriters

There’s even a third layer of companies, usually large banks or insurance companies like Fortegra or Assurant, that underwrite many contracts. Administration companies will take out insurance policies on their extended warranties with these companies, so that if the administration company runs out of money, you can still get your claims paid.

Many states require administration companies to provide for a guarantee that claims can be paid if the administrator has financial difficulties. Insuring the contracts is one way administrators can do that.

Steve usually won’t have to deal with the insurance company directly unless the administration company goes out of business or can’t pay for a repair. And not all contracts are backed by an insurance company. Some administration companies may choose to deposit a bond with the state they’re selling the contract in, or “self-insure” if they have a large-enough company net worth.

But if you buy an extended warranty that is backed by an insurance company, you’ll want to be sure you’re told which company insures your contract, and how to contact them. You may need to make claims directly through the insurance company if the administration company goes out of business or unfairly refuses to pay for a repair.

As if marketers, administrators, and insurance providers all having a hand in your extended warranty weren’t confusing enough, sometimes a single company will play two roles, or even all three. You might find yourself dealing with a marketer like Endurance, which also administers its own contracts. Or the marketer might hand you off to an administration company like Zurich that also acts as its own insurance company. Sometimes all three roles are taken care of by just one company, such as Mercury Insurance.

What all that means to Steve is that he has a lot of research to do before he chooses a service contract/warranty company. He needs to investigate the company selling the contract, and the company administering it. It’s also not a bad idea to check out the insurance company backing the contracts, just in case.

To do all of that, Steve needs to see the contract he’ll be signing. It should name which company administers the plan, and it’s likely to also name the insurance company backing the plan, if there is one. If it doesn’t, Steve should ask for that information before signing. A good area to research is whether there are any complaints against those companies.

Simply doing a web search for “(company name) + complaints” can get you a broad overview, though you have to be careful because search engine results can be manipulated by buying ads or by tailoring a website meant to obscure complaints to rank higher in the results.

Sometimes a better way is to find your state’s consumer protection agency, or whichever department regulates service contracts for vehicles, and check their websites for complaints against the company, if you’re feeling adventurous. That won’t work everywhere - some states don’t release public records of complaints against businesses. But if your state does, it can be a great resource to get a better idea of how the company you’re researching operates.

The Better Business Bureau can also be useful because they’ll often have consumer reviews of companies - even ones that aren’t BBB members.

There’s an even easier way to research service contract companies, because we’ve already done some of the work for you. Our 8 Best Extended Car Warranty Companies in 2021 article is a great jumping off point to start your research.

Top Rated Warranty Companies

4.9 of 5

CARCHEX is one of the largest, most highly-rated providers of vehicle extended warranties in the market. They have been a trusted name in the business for 20 years.

4.9 of 5

autopom! is well known in the industry for customer service and responsiveness. The company works directly with 2600 certified repair facilities and has a dedicated customer advocacy program.

4.9 of 5

Liberty Bell has one of the best reputations and covers more vehicle makes than other warranty companies. This provider has a solid reputation with excellent customer service ratings and has been around for over a decade.

4.3 of 5

Toco Warranty Corporation is a relative newcomer in the industry, but they are making a splash. They maintain a solid reputation with an A+ rating from the Better Business Bureau. Toco is known for offering affordable plans with no down payment and the ability to pay in monthly installments.

What is a Vehicle Service Contract?

Once Steve’s done his research and found some companies he thinks he can trust, he needs to look at their contracts to make sure he’s happy with the terms. There are several points to look out for in the contract, and since contracts tend to be written in legalese and not plain English, it’s sometimes hard to figure out exactly what the terms are.

But it’s important to do so, because that contract is what’s going to determine if you get what you want from the deal, and plenty of people don’t. Over the years our community forum has had lots of people posting questions and complaints about service contracts, and they’re often not happy with the deal.

Exclusionary vs Inclusionary

Probably the most important thing to check in the contract is whether the service plan is inclusionary or exclusionary. An inclusive contract tells you what is covered. An exclusionary contract tells you what is not covered.

That’s an important distinction. If your extended warranty is an inclusionary contract, you can expect it to only cover the parts or systems directly mentioned in the contract. If your car needs a new alternator, but alternators aren’t specified in an inclusionary contract, you’ll probably have to pay for that repair yourself.

Many industry experts say exclusionary contracts are better, because they will list what they don’t cover. If your car needs that new alternator, and alternators aren’t on the exclusion list, you should be covered under that contract.

Keep in mind that even if the contract says it’s a bumper-to-bumper extended warranty, there’s probably a section where it tells you what won’t be covered. Many states actually mandate this - their laws require service contract companies to list any exclusions to coverage in writing. Read more about State by State laws here.

Often things that commonly wear out, like brake pads, aren’t covered but it’s not uncommon to find other, non-wear items excluded as well. You need to know what is and is not covered before you can decide if the plan makes sense for you.

What’s included or excluded can be confusing, and can be different with each plan. Make sure the contract defines its terms, and that you understand what they mean. You might think “powertrain coverage” means the plan will replace the clutch if it wears out. After all, it’s part of the system that gets power from the engine to the wheels, right? But it’s pretty likely the clutch will be excluded from coverage.

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How to Make Claims and Get Repairs?

After you determine whether the contract you’re looking at is inclusive or exclusive, you need to find out the procedure for making a claim on it if your car breaks. This can vary widely depending on the company issuing the extended warranty.

Many contracts will require a deductible when you make claims. Some charge you a deductible per repair, and others per visit. That can become an important detail if you bring the car for repair, but the repair doesn’t work. You may end up owing two deductibles, depending on your contract.

Some contracts require prior approval before you bring the car to a shop. If yours is one of them, you’ll want to learn, before you need it, how to get that approval. Once you’re ready to take the car to the shop, you need to know how the job will be paid for.

Some companies pay for the service directly. You’ll only have to pay for the deductible, if there is one, when you get it repaired. Others require you to pay up-front, and then reimburse you later. If yours is a reimbursement contract, you will want to find out how long it takes to get that reimbursement. And you’ll need to have cash or credit reserves so you can pay for repairs up front.

How Will the Repairs be Performed?

Your contract should specify its requirements for repair. For instance, it should tell you if the extended warranty company may use non-original or used parts to fix your car. Bear in mind that “used” and “reconditioned” parts are two different things. A reconditioned part is a used part that’s been rebuilt to function like a new one. A used part is one that was taken off of one car, and put on another without rebuilding it first.

Your extended warranty contract should also tell you about any restrictions it places on where you can take your car. Some contracts require you to use a company-approved shop. If yours does, you’ll want to find out what you should do if there aren’t any approved shops within reasonable distance from where your car breaks down.

You will also want to find out when the extended warranty coverages apply. Will coverage end if you put too many miles on your car? What if you modify the car in some way? Do you have to do anything to maintain coverage? Most contracts will expect you to keep the car maintained, like getting oil changes on schedule. Some require you to have that maintenance performed only at shops they authorize.

In the opposite direction, you’ll want to know if the extended warranty duplicates the factory warranty. If your car has a three-year factory warranty, and you buy a five-year service contract when you pay for the car, it’s likely that the contract will really only be in effect for those last two years after the factory warranty expires. Before that, the factory warranty will pay for any needed repairs.

What if You Want to Cancel Your Warranty?

If you decide the service contract isn’t a good fit for you, how will you cancel the contract? Will you even be able to? Many states require extended warranty companies to let you cancel early on, often within 10 or 20 days, as long as you haven’t already used it. But what if you want to cancel after that? Some contracts will not allow that. Others will pro-rate your refund, charging you for the months the plan was in effect. Some will charge an administrative fee for cancelling.

There are several other things to check as well - we’ve assembled this handy checklist to use when shopping for service contracts.

Service Contracts Can Vary Based on State Laws

Once Steve’s done a lot of research and settled on a few companies to get quotes from, well, he’s still not done. Steve needs to get a good idea of the laws his state has enacted which regulate the service contract industry, so that he can see if the companies he’s considering are following the law. While many states have adopted a mostly uniform regulatory framework called the Service Contracts Model Act, several others have not.

State laws regulating service contracts vary from nearly nothing on the low end, to very tight regulations and felony charges for violating them on the high end. We've put together a state-by-state highlights reel of laws that affect service contracts here.

Armed with your research on companies and state laws, you’ll be in a pretty good position to evaluate whether or not the service contract you’re considering will do what you expect it to. But you still don’t know the answer to perhaps the most important question…

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Is an Extended Warranty Worth It?

So, now Steve’s done all his research. He’s investigated reviews and complaints, checked out his state’s laws, and made sure the companies he’s considering are on the up-and-up. Now it’s time to get quotes and decide whether or not a service contract would be worth it to him. And for Steve, it might not be. It depends on many factors. See our article about how to decide whether or not a car warranty is worth it for you.

Service contracts often cost thousands of dollars. If Steve’s car doesn’t require at least that much in repairs during the contract period, then he’s lost money on the deal. And remember, Steve’s considering a service contract for a Lexus, one of the most reliable cars out there. The brand consistently places in the top five in Consumer Reports’ reliability rankings.

So a service contract might not make sense at all for Steve because he’s driving one of the cars that’s least likely to need repair. But what if you pick a car that’s, well, not known for reliability? We made Steve up for this article, but there’s a real-world example of someone who came out decidedly ahead in service contract math.

Automotive journalist and car reviewer Doug DeMuro bought a Range Rover from Carmax, and at the same time bought Carmax’s 6 year bumper-to-bumper “warranty” for $3,900. In a series of articles and videos throughout his warranty period, DeMuro revealed that his Range Rover broke so often that the warranty more than paid for itself within 2 years. And then kept on paying. And paying. At the end, DeMuro said, it’d paid out more than the whole car was worth. In fact, he wrote, it ended up costing so much that Carmax more than doubled the price of the extended warranty for Range Rovers.

But DeMuro’s experience is pretty rare. Most people who buy extended warranties end up either not using them at all, or using them to cover repairs that would have cost them less money if they’d just paid for the fixes rather than the service contract. Even if you’re promised a refund at the end of the contract if you don’t have any claims, you’ll only get some, not all, of your money back. After all, these companies are in the business of making money, not losing it.

We asked DeMuro for his thoughts on whether or not extended warranties are worth it. “I think CERTAIN extended warranties are a good move for CERTAIN buyers and on CERTAIN cars,” he wrote us. “I would only advise an extended warranty either A) on cars that are known to be troublesome or problematic, presuming the warranty cost isn't excessive OR B) I would advise it for people who have a low risk tolerance or a lot of anxiety around car repairs/maintenance/ownership costs.”

That last statement might be an important consideration. Even if it’s unlikely that a warranty will make strict financial sense, a buyer might find that not having to worry about big car repairs is worth paying for. “In that sense,“ DeMuro pointed out, “a warranty can certainly be worth it if it didn't actually make you back the money you spent on it (just like insurance, frankly).”

For another perspective, Car Talk turned to Consumer Federation of America Executive Director Jack Gillis for his take on extended warranties. From a financial standpoint, Gillis says that in general, service contracts aren’t a good deal for consumers. “If they paid off,” he says, “they wouldn’t be sold.” Gillis suggests that instead of buying a service contract, put the money you’d pay for one into a savings account. “You’ll have an increasing nest egg to draw on if you have a large post-warranty repair or, more likely, you’ll be building up your down payment for your next car.”

There are, of course, edge cases like DeMuro’s Range Rover, but even those are going to be rare. Companies selling extended warranties base their pricing on actuarial tables which take into account the expected frequency of repair, and how much those repairs will cost. Actuarial tables streamline the warranty price calculation process; a salesperson simply plugs in the year, make, model, trim level, and mileage of your vehicle, and the computer uses the actuarial tables to calculate a price based on a number of factors.

If a car tends to break more often, or is more expensive to repair when it does break, the price of the extended warranty will usually reflect that. What that boils down to is that you’ll probably pay more for a service contract on a Mercedes than you will on a Honda.

That’s because service contract companies price their products based on a concept called “expected loss costs.” That idea takes into account things like the make and model of the car and how reliable that brand and model has been historically. It also considers special equipment the vehicle has, such as four-wheel drive or high-tech items that may be likely to break, or be expensive if they do malfunction.

There are other factors to consider too, such as how long the service contract will cover the car, and if any of that coverage is overlapped by the factory warranty. And of course, what coverage options you choose will affect the price you’ll pay for the plan.

The price of an extended warranty is almost always calculated so that on the whole, everyone in the selling chain makes money rather than losing it. That’s one reason Car Talk generally recommends buying extended warranties directly from the administrators when you can. That skips the sales company, which may lower the cost of the plan since it doesn’t have to take the seller’s cut into account. Again, take a look at Car Talk’s recommendations for good warranty companies here.

In fact, generally there’s a lot of profit in the extended warranty industry. According to Gillis, “Typically, dealer markup is 50% and the holder of the contract likely charges twice what it cost them.” So on a $1,600 contract, “the dealer pockets $800, and the service provider makes another $400 so that leaves about $400 in the kitty to pay for actual repairs.”

That $400, remember, was derived from an actuarial process that determined you’ll most likely have around $400 worth of repairs needed on the car while the contract that cost you $1,600 is in place.

Of course, these are merely sample numbers (based on real percentages) and there are some nuances involving when and how the various players make their money. For instance, the profits often aren’t dispensed up front; otherwise an extended warranty company might have to claw back profits from the sales company if the buyer decided to cancel the contract. But as a general rule, the extended warranty business is one which makes companies a lot of money.

As DeMuro said earlier, that doesn’t necessarily mean extended warranties/service contracts should always be avoided. For some, it’s worth even a likely financial hit just to have that peace of mind that if something does happen, they won’t be on the hook for the whole repair. It’s a sort of “spend a little more money now so I won’t have to remember to keep money in a savings account just in case” strategy. Regardless of why you’re buying an extended warranty, you should keep in mind that, on average, you will pay more for the service contract than the contract will pay to fix their car.

Now that you’ve read the Insider Scoop, you’re armed with the knowledge you need to make informed decisions on whether, and where, to buy an extended warranty or service contract. If you still have questions, head over to our forums and ask the helpful folks there. You can also refer to Car Talk’s reviews and information involving extended warranties here.

Editor's note and disclaimer: Car Talk is supported by our fans, readers and listeners. When you click on some of the links on our website, we may receive referral compensation. However, you should know that the recommendations we make are based on our independent editorial review and analyses.
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