Extended Warranty Math, Nose Hair, and Opportunity Costs

Thought experiment/assumptions/sample equations/running actual numbers:
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$2400 was the offer for an extra 5 year bumper-to-bumper. I didn't bother negotiating and declined outright; if I had any expectation of having a lot of expensive fixes, I wouldn't have bought the vehicle I did. I also declined on the basis that--if extended warranties actually paid off--the companies offering them couldn't stay in business.

But, I wanted to figure out exactly what the difference in "being covered" on paper would cost me. Let me see if I can remember enough from Mrs. Jackson's algebra to muddle my way through 1) the absolute cost, 2) cost in terms of opportunity, and 3) benefit to dealer.

Out of pocket costs
Like most folks, I financed a portion of my purchase over my down payment and trade. Let's assume I had chosen to roll the $2400 into my financed amount for 5 years, a fairly common term.

A=P(1+rt) where A is the total amount that will be paid, P is the principle borrowed, and rt is rate * time. (Thanks Mrs. J, you're the best.)

A = $2400 (1 + .0179*5)
A(just the cost of the warranty over 5 years) = $2615

Let's assume I borrowed $20K on a balance of $33,000 (vehicle incl. TTL).

A= 20000 (1 + .0179*5)
A(total cost of purchase w/out warranty over 5 years)= $21790
/60 = $363

If you include the $2400 to my $20000 purchase, that changes the total amount paid over five years to $24404.


So, there is your absolute cost, over 5 years, of tacking on an extended warranty at point of sale: an extra $2615, or $406 per month versus $363.

However, you have a bumper-to-bumper for 3 years on driving off the lot. Your powertrain goes to 5 years. So, you'll enjoy zero benefit for a full 3 years (at least) and (most likely) 5 years. Even if your engine falls off at 5 years and a day, you just paid $2615 for one day's worth of coverage.

You just let them capitalize on your $2400 for 3 (or five) years, and handed whoever is holding your note $215 dollars.

What's that in opportunity cost?

If you invested $2400 in stocks netting a 5% rate of return over the same 5 year period, you would have = $3063 dollars. If you declined extended warranty coverage altogether, that's almost enough to (pick one) do major engine or transmission work.

The opportunity costs are enormous--instead of being up the $3063 that you now don't have because you bought a warranty, you're also down the $2404 you don't have that you spent on a warranty, for a total opportunity cost of nearly -$5500; with almost $700 of that just in the swing from you earning YOU interest to paying THEM interest, again--that's for 3 (or 5) full years with NO, and I mean ZERO benefit.

Dealer benefit
The dealer? They just scored $2400 in cash through your financing. They will turn around and invest that in the dealership, the owner will buy a new gazebo, the salesman will take his 8 year old suit to the nice Korean lady for another patch, and the lights will stay on at Toyota of AwesomeTown for another few days. I've got very few quibbles with people making money off of others' willfulness--as long as we're talking about literate adults--to throw money at them. My property taxes went to warming a seat where they were supposed to be exposed to basic math, after all.
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Results:

So, there you have it. A $2400 extended warranty from the dealer will lose you -$2615 over five years; you'll be down -$5100 over five years as opposed to stuffing that $2400 in a mattress and keeping it there for 5 years, or -$5500 versus putting $2400 in the stock market with an assumable 5% RoR, with zero tangible benefit to you (to use a powertrain example).

Obviously the bumper-bumper at 3+ would change the numbers/time frame benefit accordingly.

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Conclusions:

1) We should all temporarily get in the business of selling extended warranties on new vehicles, for exactly 3 (or 5) years, and retire to a country with no extradition agreement not one day later than that.

2) You get zero benefit from buying an extended warranty at point of sale on a new vehicle for years and years and years, or years and years and years and years and years, depending.

3) $5500 will go a long way to helping you avoid financing your next purchase, snowballing the effect of keeping more of your money in your pocket.

4) It will always be cheaper, on average, to self-insure against mechanical breakdown and do the routine maintenance that keeps you out of the shop. *HOWEVER* if you can't afford to self-insure against mechanical break downs, or decide that "peace of mind" in warranty coverage is better than peace of mind in your bank account, then shop around for your best deal and do it only AFTER your factory warranty is about to expire.

5) Think hard before you "just roll it into your loan". The difference between $360 and $405 may not seem huge, but take a long look at that finance guy, with the weird stache and threatening nose hairs--do you *really* want to fork two cases of long neck brews in tribute over to that guy every month, of every year for five solid years for *nothing* in return? I bet you normally wouldn't drink with ol' Octopus Nostrils if someone was paying YOU!

Your money; your choice. Just some food for thought. Ran a bit long. Sorry.

edit: oh...you would adjust upwards a wee smidge (assuming a low interest rate and 5 year term) for the compound interest formula. I used the simple interest formula in the interest of...well, simplicity.

 

I'm happy anytime I see someone put good logic to use when making a decision. Kudos to you!

While I like your thinking an analysis, you've undervalued the repair cost (well over $3,000), took the high end dollar amount ($2500) for the 8 year warranty and assume a lazy and uninformed consumer not willing to maximize their consumer surplus.

With some diligence and an email to Troy Dietrich, one could get an 8yr/100k miles extended plat warranty for under $1,050.

Now if I apply for a Toyota credit card and finance the $1050 at 0% for 12 months I can avoid paying interest on the warranty. (Anyone willing to pay interest on a steeply depreciating asset is making a poor financial decision imo).

Lastly, by deferring the purchasing of the extended warranty (can be purchased anytime within the first 3yr/36k miles by the original owner), I can earn interest on the principal and then use the money to pay for the extended warranty.

So doing the reverse, $910 today would yield a future value of $1,050 3 years from now with 5% growth. At this point, I could purchase an extended warranty plan closer to when my actual 3yr/36k expires and provides actual value. There is still some opportunity cost (the $1,050 over 5 years @5% has a FV or $1,340), but at least I have a value to weigh against the chances of my vehicle breaking down.

 

All very valid and reasonable points. The number of variables gets quite high in terms of cost comparisons if you try to factor in required (?) maintenance at Toyota authorized service bays, how much you can negotiate down on the price, and etc. etc. etc.

I took the extreme case of (hypothetically) saying "yes please may I have another" to what Finance Guy put in front of me, in terms of point of sale, in my example, with special emphasis paying money now and not getting anything for the money for nigh on 3-to-5 years.

 

oldswab...

u still have the opportunity to get the extended on your own before the 3/36,000 is up, and going with Troy saves a huge bundle, one time fee $1,050, to extend to eight/100,000, an extra five years of warranty for a mere $1050...$210/yr, dirt cheap....

since I am one to make things simple, I would opt for the one time $1050 @3/36,000...

you did make the right decision no matter how you got to the decision....

 

did you actually purchase this warranty from Mr. Dietrich?? very interested

 

Hey guys,
Before knowing about Troy on 11/17 when i picked up my taco, the dealer suckered me into the 8yr 75k warranty for 2495, insisting that its already 50% off. Well i found Troy's info, and promptly requested a full refund from Toyota financial. I was pretty impressed and got my refund in 2 weeks back to me in Cash not credited to my loan.
Contacted Troy right away and he was really easy to get a hold of. Purchased the 8yr 75k plan for $709 Can't beat that at all.

He has some pretty good deals on the service plans too, but I didn't get one.

 

$2400 is way too much for an extended warranty. They can be purchased for way less.

 

If a company sells something, in this case an extended warranty, it isn't out of the goodness of their heart that they want to help you out. It is because they are making money out of it.
Let's be honest. How many repairs are really required on a 5-8 year old vehicle if you drive it correctly and keep up with the maintenance?

My favorite line when buying a car is "well, if you really think I need this extra warranty, Toyota must not be as good of a car/truck as I thought. Maybe I should go with a more dependable brand."

 

I tried to make a deal with my stealer that goes like this:

I will buy the warranty but when it is over, if I didn't use it for anything, no matter how big or small, you give me back, in cash, half of what I paid for it.

That is close to a win win deal for both in one form or another.

They wouldn't go for it so I bought nothing as far as extended warranty goes.

If I get another 10 k miles with no major problems, I win all around in that the 100K warranty would be over.

 

I've never bought a extended warranty. Don't plan on it either. Your math and logic seem sound!

The funny thing is... I still get mailers for vehicles that I haven't owned in over 5 years for extended warranties.

 

I declined the extended warranty when I bought mine, I had to say NO like a hundred times, jeez they really really want to sell the things bad.

 

The math there is awesome.

These guys get a huge boost in commission when you buy the extended warranty. The key to this negotiation is to make the guy in the finance office negotiate your APR down (assuming you work with Toyota Motor Finance).

For my Taco, I offered nothing upfront, received a low interest rate. I told the sales guy no on everything extended, went to the finance office on a deal I had already agreed to. The finance guy did a second effort on the warranty, which I expected. I told him if he got my interest rate lower so that it made sense, I'd do it. He made one phone call, and my APR instantly dropped 4.5%. Keep in mind that not only was I financing the truck, but rolling over my previous auto loan into this vehicle, so the total amount financed was over $40k.

At the end of the day, I'm paying ~$90 less per month at a lower APR and have the extended coverage in the event anything does happen. Could I have negotiated this without jumping on the coverage? Perhaps. But, bottom line, this is something the dealership really wants. Might as well use it to your advantage.

 

I'll say here the same thing that I say in the other threads that discuss the extended warranties: You are essentially buying a form of insurance. In may cases it is a good idea to have it and not need it, than need it and not have it. As mentioned, many extended plans can be bought for just over $1000. The $2400 is way too high, I agree. As for repair costs, sure, the Toyota is a reliable truck, but think for a bit. How many people here in JUST OUR FORUM talk about this or that breaking or failing? Sure, the Toyota is reliable, but it still, and does break. The average cost of an engine replacement is well into the $5k-$6k mark. A transmission can easily reach $4k, so you estimation of a repair is a bit off there.

OK, maybe you will never need it. I have auto insurance in case of an accident. I haven't had one in over 15 years. But you never know. And THAT is what you are buying. You are buying a policy to cover repairs JUST IN CASE. And that just in case happens more often than you think. Over the past 3 vehicles I have bought, I got extended warranties on 2 of them. (The most recent purchase was my 97, so no extended coverage available, or I would have got it) Of the two that I did get this policy on, we had calculated out that we spent less than $2k total, including finance charges (I don't finance over 5 years, that's just crazy) On one I had a window regulator fail, and a transmission fail. The other one I had an engine fail. Both vehicles had full repairs covered. In both cases I saved a total I think it was of somewhere around $7k in repair costs.

Remember here, you are basically buying an insurance policy. Sometimes you never need it, other times it will save your ass. Especially if you have en engine failure at 4 years, while you still have 2 years left to pay for the truck on a 5 year note. Nothing can screw up your finances more than a sudden $5k expense that you didn't expect.

 

http://www.tacomaworld.com/forum/2nd-gen-tacomas/297519-my-11-tacoma-75k-miles-later.html

I still have 35 thousand miles of extended warranty left on my truck. I've already more than recouped my initial cost. I figure that in my case, an extended warranty was a wise decision.

 

I've bought ext. warr. on every vehicle. Used it on every vehicle. Made out on every vehicle. Bill's explanation is well put.

 

Geico MBI $ 17.00 year /250.00 Deductible

 

Agreed. I also don't evaluate purchase decisions based on whether or not the seller is making a profit. If I only bought items when the seller lost money I'd be living in a ditch and wearing a grass skirt. Yes, dealers make money on extended warranties (duh). If the cost of the warranty exceeds the perceived value you get from having "repair insurance" then don't buy it.

 

A big part of the decision is based on how long you keep your vehicle. I usually keep mine more than 7 years. Shopped warranties and got mine for about $800 bucks. Has paid for itself on previous vehicles. A transferable warranty can also boost resale value.

If you only keep a vehicle 3-5 years there is less value in getting the warranty.

 

I think my general conclusions were to keep your money while the factory warranty was in effect, and to shop around for the best deal before it expired...if you are unable to self-insure against predictable mechanical failures.

That deal above for ~$800 actually sounds really good, if you are in the market to gamble $800 on the hopes of buying a vehicle that the engine/trans/AC falls apart... I spent $1,800 1998 dollars (just got back off of deployment and was pretty flush for a 22yo) on a similar plan, and got a $2,400 AC job out of it before I parted ways with my wayward Explorer...

I want to emphasize I'm not being critical of extended warranties...free market and all, and they are entitled to sell what ever folks will buy without being brazenly fraudulent. And, they often add dollars to your local economy. Whippee!

I just wanted to make myself aware of my potential costs and decided to share those thoughts around.

 

I purchased the zero deductible platinum 8 year/75000 mile warranty for my 12 from Jerry at Midwestern last year for $634, I know Troy offers great pricing also but I was repeat customer of Jerrys. Personally for me is was pricepoint, I would never pay what dealers ask but the $634 for 5 additional years was a cost I was willing to pay. I bought then as I was fearful internet pricing would not be available in 3 years and also costs tend to rise. Warranty is transferrable and would help resale, is also prorated if I decide to sell without warranty or I want to cancel.