Our general advice: don’t buy an extended service contract. For most of us, they’re just not worth the cost. But if you want one, here’s some advice on getting the best deal.

Why Bother?

Extended service contracts for automobiles produce big profits for the dealers that sell them and the extended service contract companies that back them. On a contract for which you pay $1,000, the average payout for claims might be less than $250, with the rest going to administrative costs and profit.

Many new cars are very reliable, so there are few service claims. Also, many cars now carry long manufacturer warranties, so many service problems are covered by the warranty, leaving little to be covered by the extended service contract.

But millions of new car buyers each year buy these contracts. What you get, the salesperson will argue, is “peace of mind.”

You don’t have to rush your decision on whether to get a service contract or what and where to buy. Most service contract companies allow you to sign up long after you have purchased your new car. With most, you can delay the decision for at least the lesser of one year or 12,000 miles, and in many cases, you can wait until just before your new car warranty expires.

Our general view on service contracts, which are simply insurance against repair bills, is the same as our view on other types of insurance. Don’t insure unless a possible loss—a large repair bill—would be very disruptive to your life. Why pay administrative costs and profits to an insurance company if you could simply “self-insure” and pay any unexpected bills out of your own pocket?

The case for getting an extended service contract is strengthened somewhat if—

  • Your car has a lot of options and accessories—power seats, performance packages—that might break down and that would be covered by a service contract.
  • Your car has needed a surprisingly large number of repairs during the early months of your ownership.

  • You plan to keep the car at least six or seven years—through the duration of the contract. With most contracts, if you sell or trade your car to a dealer, you get only a pro rata refund for the period remaining on the contract. For example, if you have a six-year contract and sell the car to a dealer after three years, you get only half the contract price back. But most of the actual value of a contract is in later years—after the new car warranty has expired and when the car is older and more likely to need repairs.

Choosing a Contract

If you decide to buy an extended service contract, you have many options. You don’t have to buy your extended service contract where you buy your car or where you plan to have it serviced. For example, you can buy a Ford at one dealer, buy a Ford-sponsored service contract at another Ford dealer, and have the car serviced at any Ford dealer in the country.

Your first step in buying a service contract is to review the provisions of available contracts to see exactly what is covered. You can get brochures describing contracts from local dealers. The Federal Trade Commission urges you to review a copy of the actual contract you will receive rather than just a brochure, but many manufacturers don’t give their dealers sample contracts (you get a contract in the mail after you sign up); so it may be difficult to see one to review.

You’ll find substantial variations in what contracts cover. Almost all contracts exclude from coverage maintenance and wear items, ranging from brake parts to exhaust system components to air filters. And many contracts exclude—or fail to include—many additional items, including electrical devices like power windows and radios, interior trim, gauges, and even air-conditioning systems. Some contracts cover only a specified list of items and you’ll probably have a hard time judging whether important items are left off the list. You’re better off with a contract that covers everything except a specified list of items.

Some contracts cover the cost of towing and a rental car but others do not. Some contracts cover parts but not all the labor necessary for diagnosis and repair. And most contracts require you to pay a “deductible” amount for each repair—in some cases, as much as $100—before the service contract company pays anything.

Be sure to check where you can get repairs done—at the selling dealer only, at any dealer of your make of car, at any new car dealer, or at your choice of new car dealer or independent repair shop. Since consumers tend to be more satisfied with repairs at independent shops than with repairs at new car dealers, it’s good to have the option of using an independent shop.

Also, check how the shop will be paid. Under some contracts, the shop simply bills the contract company; under others, you must pay the shop, then seek reimbursement—often long-delayed—from the contract company. Even if a service contract company says shops can bill it directly, check with repair shops you might use to be sure they will in fact bill the contract company; most independent shops have long since decided not to put up with the hassle of collecting from service contract companies. Shops will be more willing to deal with contract companies that allow the shop simply to charge the repairs to the contract company’s Visa or MasterCard.

Finally, find out the name of the company that backs the service contract and be sure this company is financially sound. Many of these companies have gone out of business in recent years, rendering their contracts worthless. You are probably safest with a service contract backed by an auto manufacturer like Ford or General Motors.

Keep in mind that the same contract sponsor—Ford, for example—usually offers several different contract options. The more you pay, the more coverage you get.

Choosing a Dealer

At least as important as choosing a good contract is finding a dealer that will sell it to you at a good price. Dealers make a big markup above what they pay for these contracts. One study found that among a sample of contracts it examined, backed by a major manufacturer, 92 percent of the customers paid at least $200 above dealer cost, 24 percent paid at least $600 above dealer cost, and three percent paid at least $900 above dealer cost.

You can call dealers and explain that you are shopping for a good deal on an extended service contract. Ask them what they offer and at what cost. And if a deal seems attractive, ask the dealer to email you a copy of the brochure or, better still, the full contract and be sure to get the sales person’s contact information to call with questions or to purchase. The best way to complete your service contract purchase is by phone, using a credit card.