When you buy a new home you always have the option of purchasing a home warranty that, theoretically, covers the cost of repairs to various appliances and other home systems. But are these home warranties worth it and what should you be aware of before you actually buy one of these?
Before I get into some of the nuts and bolts behind these home warranty products let me explain that I actually managed the extended warranty program for Circuit City Stores for a period of time and these home warranties are a very similar product. In addition, I've studied the economics of insurance before and home warranties are basically insurance policies. So I know a fair amount about the economics of home warranties.
A Home Warranty Is An Insurance Policy
When you buy a home warranty - and they start around $420 - you are basically buying an insurance policy. The reason this is important to recognize is that insurance companies are in business to make money and that means that they expect to make money on the average policy they sell, which means that on average the people who buy these policies will lose money. Buyers will most likely pay more for the policy than they receive in return over the life of the policy.
Then why would you ever buy an insurance policy? Because you are willing to trade off the certain cost for a very uncertain cost. The insurance company can play the averages game but many consumers cannot or don't want to play that game and they are willing to pay a premium for the certainty. This is especially true as it relates to health care where a catastrophic illness can cost over $1 MM.
But when it comes to home appliances and other systems what is the worst thing that can happen? Maybe you need a new air conditioner or a refrigerator that might cost you a couple of thousand dollars. So for people who can handle that type of expense out of the blue, there is no need for them to buy an insurance policy - they basically "self-insure" from their own savings. But if a new air conditioner would break the bank then you might want to consider getting a home warranty.
How To Beat The Home Warranty Companies At The Averages
There is one advantage that the homebuyer has over the home warranty companies. They know more about what is being insured than the warranty company does and this asymmetrical information allows them to make a better decision about when to buy the warranty than the companies can make about when to sell the warranty. In fact, the companies will pretty much sell a policy on any property to any buyer because they just can't afford to inspect every home before issuing a policy. But a buyer is going to be more likely to buy a policy when they can see that a home has been poorly maintained - e.g. a trashed short sale - and is, therefore, more likely to develop problems. That's what I did when I bought my short sale. I bought a policy from Home Warranty.
This asymmetrical information leads to a problem for the warranty companies called adverse selection - the tendency of these companies to get stuck with bad deals. Consequently, they have to raise their prices to offset this bias, which means that anyone who buys such a warranty on a well-maintained property is overpaying.
Beware The Exclusions
It's important to understand what you are really buying when you get one of these home warranties. The contract is full of fine print which excludes a huge list of situations that you would reasonably expect to be covered such as:
- Improper installation
- Plumbing fixtures
- Whirlpool jets
- Ejector and sump pumps
- Doorbells associated with intercom systems
- Alarm system repairs above $400
- Security video equipment
- Central vacuum cleaner repairs above $400
- The remote components of an automatic garage door opener
- Ice and water dispenser in a refrigerator. In fact, it's not even clear if they cover the ice maker in the standard policy. I don't think they do.
That's just a small sample of my CoverageInsure Home Warranty contract. The entire list is enormous. But you can buy a higher cost policy that will cover some of these excluded items. Like I said...these guys are in business to make money.
Beware The Pre-Existing Condition
Just like in healthcare these home warranties have pre-existing condition clauses. When you call in a claim they will ask you a series of questions and if your answers indicate that you don't know for sure that this item ever worked properly since you owned the home then they will simply deny the claim. Now you can buy a premium plan that will cover unknown pre-existing conditions but, even then, if they somehow determine that you knew the item wasn't working when you bought the plan they will deny coverage.
Beware The Deductible
Just like in healthcare you have to pay a deductible for every claim made. On my Home Warranty contract, it's a trade call fee of $100.
The Warranty Company Does Not Guarantee All The Work Performed
This one really burned me up. The home warranty companies contract with various repair companies to actually perform the work and they will make sure that your reported problem is ultimately solved. However, apparently, and once again I can only speak from my experience with Home Warranty if the contractor's work directly or indirectly damages your home or appliance you are on your own to work out the issue with the contractor. CoverageInsure will do nothing to help you resolve the issue other than note a complaint in their system for future reference in dealing with the contractor even if CoverageInsure sent out an unqualified contractor in the first place.
For instance, we had a gas leak in our dryer and CoverageInsure sent out Bender's Plumbing of Addison to fix it. They fixed the leak but after they left we discovered that the dryer was no longer venting outside. Bender's Plumbing was dispatched again to fix this problem but incredibly they decided it wasn't their problem. Reluctantly we paid an appliance repair guy $80 to fix it and he explained that when Bender's moved the dryer the vent hose disconnected and was then crushed as the dryer was moved back in place. If Bender's had known what they were doing they would have opened a panel on the front of the dryer to reconnect the hose and pull it out of the way as they slid the dryer back in place.
Bender's initially promised to send me a check for $80 but it never arrived and then they wouldn't return my phone calls. And even though CoverageInsure should never have sent out a plumber to do an appliance repairman's work they refused to help resolve this dispute.
Your Realtor Gets A Commission For The Sale Of A Home Warranty
And this is a lesser concern because it does not involve a lot of money but your realtor does get paid a small commission to sell a home warranty. It's around $70 I think, which is such a small amount that my company rebates it back to our clients to avoid any conflict of interest however small. But you should still be aware of this because some realtors will do anything for a buck.