Nearly all big-ticket items — from cars to TVs to power tools — come with a warranty.
The idea is simple: If a consumer shells out significant cash, they want either the manufacturer or the seller to stand behind the product that's being purchased.
In addition to these warranties, however, many big-ticket items are now eligible for additional coverage through service contracts.
And most of the time, these service contracts are a bad idea.
Though frequently called "extended warranties" in marketing, the Federal Trade Commission designates these agreements as service contracts because that's what they are — a contract for continued service, at additional expense, that is wholly separate from any other purchase guarantees.
Consumers who confuse a warranty with a service contract can underestimate both the quality of their coverage, as well the amount of money they will end up spending out-of-pocket on these plans.
And in some cases, they may not realize they are paying for coverage they already have free of charge.
Service contracts come in all shapes and sizes, but generally speaking:
Manufacturer's warranties overlap: Commonly, major appliances and electronics have a one-year manufacturer's warranty on them. Similarly, new cars commonly offer at least three years or 36,000 miles of coverage. That ensures you're not getting a defective product out of the gate, which provides enough peace of mind for most — and makes whatever service contract you're being offered redundant over that time period.
Premium credit cards can extend that warranty: Beyond that manufacturer's warranty, a good credit card such as American Express or Visa Signature can offer cardholders extended coverage simply by virtue of you swiping your card at checkout. Plans vary by provider, but many higher-end credit card programs provide one extra year of coverage above the original manufacturer's warranty, making that one-year warranty on a new TV actually good for two years. If you're eligible for this coverage at no additional cost, why pay for a two-year service contract?
Service contracts often cover a narrow window: If you're concerned that even two year's of coverage isn't enough, keep in mind that most service contracts may not cover you for much longer than that. Thus, you have to be rather lucky — or unlucky — to have problems in the narrow window after a manufacturer's warranty lapses but before your service contract coverage ends.
Service contracts are good for insurance, not cost savings: When you account for deductibles and monthly charges, service contracts can cost more out of pocket when repairs are needed. Keep this in mind. Some consumers see a service contract simply as insurance against a large one-time expense, and that's fine, but if you're expecting big savings this way you probably won't get them.
Given all this, service contracts or so-called "extended warranties" don't make a lot of sense for most consumers.
But here's how, in select circumstances, they may make sense, as long as you read the fine print.
The most common upcharge when you buy a new smartphone is warranty against damage to your fancy gadget. It's just a few bucks a month, so why not?
Sadly, the devil is in the details and there are a lot of bad service contracts for smartphones
Some policies won't cover you if you simply lose your phone. And if you think you can report it "stolen" instead, they will make you file a police report before reimbursing you. Some don't cover water damage. Others have deductibles as high as $200 for high-end phones, or a maximum on the total value of claims under the service contract.
Under a bad agreement, you could have your iPhone stolen and then spend the next week phoneless as you file paperwork, and then wind up paying a $200 deductible on top of the $10 monthly fee you're already charged for your service contract.
Getting stuck with a service contract like this is more common than you think, particularly if you go through third-party phone insurance providers.
Remember, any new cellphone comes with a built-in manufacturer's warranty to guard against glitches that aren't your fault.
And if you're simply looking for coverage in case you're taking a selfie while hang-gliding and drop your phone… well, few policies out there cover irresponsible behavior.
Many specialty retailers offer protection plans for the kinds of products they sell beyond just smartphones. The Home Depot Protection Plan, for instance, can be applied to lawn mowers or hot water heaters or grills bought at the store. Similarly, Best Buy offers Geek Squad Protection that includes repair as well as service for those who aren't electronically inclined.
However, remember that nearly every new flat-screen TV or refrigerator comes with a manufacturer's warranty that will protect you against defects that are not your fault — at least for a year or two.
And furthermore, there are very few store-sponsored warranties that will help you replace an item you destroy by misuse.
So once again, you have to read the fine print and decide if the monthly costs and deductibles make sense and whether you already are covered via a manufacturer's warranty or by an extended warranty provided by your credit card company.
There are some select circumstances when one of these store-sponsored warranties makes sense, particularly if some technical support is included for a high-tech item such as a laptop. Still, by and large you rarely get much in return for the additional cost.
Extended vehicle warranty
New cars bought at a dealership always come with a manufacturer's warranty. But for those buying a used car or driving an older vehicle where coverage has lapsed, extended car warranties offer some protection against breakdown.
Think of these service contracts as health insurance for a car, something you hope you don't have to use, but will protect you from the unexpected. And like health insurance, the cost to you is based on health of your vehicle and the likelihood of breakdown.
In other words, if your 18-year-old junker is about dead then don't expect a cheap service contract that will let you fix up Old Bessie for free.
If you are in the market for an extended car warranty, used car dealers frequently provide the best up-front price because they help give consumers peace of mind at the time of purchase. However, read the fine print on out-of-pocket costs because they may make up for the sweet initial terms with a big deductible if repairs or towing are needed.
Independent providers can offer lower premiums and greater choice of service locations, however it's even more important to read the details here. In addition to specifics on deductibles, third-party providers also may have a limited list of affiliated repair shops or exclusions to keep their costs down. If the wrong thing breaks in the wrong part of town, you may be on your own.
The devil is in the details, so always ask about exclusions and deductibles to figure out what you'll actually be paying out of pocket.
Extended home warranty
Just like repairs on an older car, the upkeep for an older home can break the bank in a hurry.
But don't confuse a service contract for your home with homeowner's insurance that protects against fire or other major property damage.
If an extended vehicle warranty is like life insurance for your car, then extended home warranties are life insurance for your appliances; and in the same way, homes with older appliances on their last legs will cost more to cover than a house with a brand new kitchen and furnace.
The challenge is that while all cars have very similar components, homes can vary broadly in the quality and quantity of appliances. That means more room for confusing language on exclusions or high deductibles, so make sure look closely at the terms.
It also is important to note that while most Americans don't replace parts on their car, it's common for a homeowner to simply go to the store and pick up a new refrigerator or washing machine. If you've made an appliance purchase on your own, then remember your manufacturer's warranties that already provide coverage.
The flip side, of course, is the fact that a new furnace can be very expensive and isn't easy to install. So if you're worried about an insurance policy against a costly breakdown to your heating in the dead of winter, then an affordable service contract may provide peace of mind.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor's Guide to Finding Great Stocks.