By Anthony Santiago - Editor-in-Chief

October 11, 2022
How Do Car Warranty Companies Make Money

How Do Car Warranty Companies Make Money

Car warranties are a great way to protect yourself from expensive repairs down the road. But most car owners aren't aware of the benefits of buying a new car warranty. They assume that the manufacturer will cover any problems with their cars.

However, you might be wondering how these warranty companies stay in business and if these warranties are scam.

Just like car insurance, there are different types of coverage and different carriers. I recommend trying to get an extended warranty from the same brand or dealership.

Third party warranty companies may have more exclusions with their bumper to bumper warranty since they have not seen the car in person or serviced by their team.

Many car manufacturers even encourage customers to purchase a car warranty because it helps them earn more revenue to their bottom line and support their service departments. Plus, future-proofing potential repairs can help close the sale of a new car as well.

FACT: Truth be told, car warranties are a great source of profit for car dealerships. And car dealerships are where car manufacturers get their profits.

In this post, I'll explain how car warranties work and how car dealerships make money. Then I'll share my top three tips for finding the best car warranty for your needs.

What Exactly Is A Warranty?

Warranties come in many forms. They are often offered by manufacturers, sellers and insurers. Warranties are designed to help protect you against unforeseen problems or damages. In some cases, these vehicle protection plans extend beyond the original manufacturer warranty period to deal with unexpected expenses.

Some companies offer extended warranties to consumers to protect themselves from unexpected expensive repair costs. These plans usually cover both parts and labor of repair facilities or repair shops. Other companies offer discounts for customers who purchase multiple items together. This way, they can reduce the price per item.

An extended warranty is not an insurance policy, but rather it is a plan that helps consumers understand the risks involved in purchasing a particular product. Expert actuaries are hired by most companies offering extended warranties to determine the likelihood of specific events happening.

Some extended warranty companies offer complimentary inspections and repair work, which saves the consumer money but services would be tied to in-network shops.

It's VERY important to review the exclusionary coverage. I know that my coverage does not include certain parts like the clutch in the transmission, although it does cover other powertrain components. 

How Do Vehicle Warranty Companies Make A Profit?

Extended warranty plans are a common part of the American consumer experience, covering everything from appliances to cars. But many consumers don't realize that most companies dealing with extended third-party warranties actually make their money off of premiums rather than actual payouts. And while some companies offer additional optional policies like roadside assistance and rental vehicle coverage, it's usually just another way to gain more money from customers.

Actuarial calculations help them determine how much to charge per month. Many companies use complicated formulas to figure out what percentage of claims they'll pay out each month. It's actually a numbers game and statically calculated to be profitable.

Financial expert, Dave Ramsey reported in his YouTube Video, that only 12% of the monies paid is actually used to pay out for repairs. The remaining 87% is used for other expenses like salary, marketing and other overhead costs. 

Consumer Reports agrees with Ramsey in an article stating, "From a pure numbers standpoint, the smart money is on skipping the protection and instead focusing on buying a model with better-than-average predicted reliability, and then properly maintaining it."

However, I do disagree with him and CR regarding expensive supercar extended warranty coverage from a CPO BMW i8. Ramey suggested that he opt out. While I agree that a normal pedestrian car like a Camry or a Chevy Blazer can be funded out of pocket, an expensive hybrid BMW i8 would be prudent to get coverage, especially if it's from the BMW dealership. 

Yes, it's more expensive but parts and labor for that model is outrageous. 

My rule of thumb is if you can wrench it yourself then it's better to opt out. But if you want peace of mind and can afford the payments it's worth getting for at least 6 months to a 1 year of ownership. 

Remember, the extended warranties do not cover routine maintenance like oil changes and tires. 

The warranty companies are rolling the dice that you never file a claim, but for expensive cars, I would opt for it. Otherwise, you might find yourself facing a bill of hundreds of dollars.

How Do Car Warranty Companies Make Money

How Profitable Are Extended Warranties?

Extended warranties aren’t regulated like car loans, home mortgages, or credit cards. There are no rules about what you pay for one and how much you have to spend to qualify for another. So it’s easy for manufacturers to charge whatever price they want. And because there are no regulations or consumer protection groups, extended warranty providers can set prices however they see fit. It can be very lucrative.

As mentioned previously, a majority of the costs are for overhead and not for paying repairs. In fact, an extended warranty can cost around $1,000 and balloon to upwards of $4,000 and more. 

My plan is about $1,800 per year for 3 years with ForeverCar so I intend to reconsider the annual renewal after the first year if no other repairs come up. The monthly payment ranged from $100-180 when I did my research. 

However, I was totally unsure of the coverage and none of the quote companies provided an email with additional information, 

In addition to the upfront costs, customers often end up paying more for products covered under an extended warranty than if they hadn’t purchased one. I know from experience, I could have saved thousands of dollars if I had purchased the warranty with Carvana at the time of purchase but opted to skip. Little did I know that I would have needed it later on for a purge valve replacement. 

Anyways, so far the experience has been good in avoiding a costly repair and SilverRock has honored the covered repairs per the diagnostics from the dealership. 

How Do Car Warranty Companies Make Money

Reasons to Purchase an Extended Warranty for Your Vehicle

A third party extended warranty plan can give consumers additional peace of mind when it comes to unexpected repairs. But does it make sense to buy one?

Extended car warranties are offered by automakers, auto parts suppliers, and independent companies. They typically cover the cost of repairing most major components of a vehicle for up to three years following purchase. 

These are not vehicle service contracts which cover routine maintenance like oil changes, brake pads and rotors and engine fluids. 

Extended car warranties cover bigger ticket items like powertrain warranty, AC, Audio systems and some electrical components. 

Most manufacturers offer free or discounted plans through their dealerships. Some even provide the coverage directly to customers. These programs usually include a deductible ranging from $50-$200 per incident. If you don't pay out of pocket, the manufacturer covers the remaining balance.

The best part about these plans is that they're often priced lower than what you'd spend buying separate policies. This is true based on my own experience. For example, a typical dealership program might cost around $1,500 annually while a comparable policy from a third party could run anywhere from $2,000 to $2,500.

But there are some things to consider before signing on.

Here are a few things to check before purchasing an extended warranty:

  1. Google the "make" and "model" with the term "+problems" or "+repair" in order to get an idea of the typical issues.
  2. Search a few forums on the most common issue for "make and model"
  3. Is your model a new redesign or due for a redesign? Typically, new models have kinks to work out and potential issues that will only appear after owners have weighed in on ownership. 

These two steps will help you determine if it's worth getting an extended warranty or not. 

How much do I trust the dealer or the extended warranty company?

If you bought the car from a dealership, chances are good that the person selling you the product knows the car inside and out. He or she probably worked on it and understands how it works.

How Do Car Warranty Companies Make Money

What is the Typical Cost of an Extended Warranty?

There are many different plans available, and they vary greatly depending upon what type of vehicle you buy. You might think that buying an extended warranty is like buying a new car. But it isn't quite that simple. Here are some things to consider when comparing auto warranties.

A typical extended warranty covers repairs for 2 to 5 years, although policies can be purchased for longer periods. You will likely pay a monthly fee for the coverage, along with a one-time setup charge. The total cost could run anywhere from $50 to $500 per month, depending on the length of the contract and the manufacturer. 

My monthly costs are a little over $150 a month which is good for 3 years.

If you decide to go with a factory warranty, you'll typically receive free roadside assistance, labor, parts, and even rental cars. However, you won't always get reimbursement for the actual repair bill. Some manufacturers offer lifetime warranties, while others require you to return the vehicle to the dealership within a certain period of time.

You'll also need to factor in depreciation. If you bought a used car, you'll probably lose value over time. On the other hand, a new car loses value immediately.

I typically like to factor in the cost of a NEW car vs a used car with repairs.

Another consideration is the quality of the dealer network. If you are buying a very reliable car or a CPO, then you most likely won't need it since there would be an original factory warranty.

However, if you purchase a used car that is not CPO'd then they often use high pressure tactics to convince customers to purchase additional products, such as extended warranties.

Long Term Repair Costs Can Help You Decide on Extended Warranties

Extended warranties aren’t something most consumers consider purchasing. They usually buy them because someone else recommended it. But what happens if you do end up needing one? Do you actually use it? Or does it just sit there collecting dust?

If you feel like you were pressured during the sales process and now have buyer anxiety if you got ripped off, don't worry. Perhaps you found that there's a high complaint volume with your extended warranty insurance provider, you can take action to stop payment and cancel coverage.

Typically you would be able to cancel your extended car warranty plan and divert that money into an emergency repair fund. 

However, I believe that Extended Warranties are GOOD if you fall under the following categories:

  1. You drive a European luxury vehicle over $20,000 that no longer has any warranty on it
  2. Your car is a domestic car over $30,000 that no longer has any warranty on it

NOTE: Asian cars typically do not have as many issues as domestic or European cars. This is based on first-hand experience. 

Final Thoughts 

If your factory warranty period is over and you are considering a comprehensive plan to protect you for the next few years, then you MIGHT consider an extended warranty. There are different levels of coverage which should protect you from paying for big-ticket items. 

However, you should look for companies that are industry leaders, have good customer experience and are known for ethical business practices. While you might not find any with a money-back guarantee, there are aftermarket warranties that offer extra coverage. 

You are in the driver's seat and you need to do your due diligence before signing up.

I personally signed up with ForeverCar since it was tied with Carvana. So far, the service has been great and I highly recommend adding it DURING your check out in order to save on costs. It would have saved me $1,500 on the contract terms.

Should you have any other questions or comments, please feel free to post below. Cheers.

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Anthony Santiago - Editor-in-Chief

About the author

I am a passionate car enthusiast who likes to help people save money and avoid headaches when it comes to cars. I believe that everyone can find the right car at the right price. I share my tips and experience so you can learn quickly and maximize your next SUV, truck or car purchase.

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