When Service Contracts Make Sense

So you're almost out the door of Big Box with your latest high-tech toy. You've already succumbed to the sales associate's exhortations to buy those expensive Godzilla cables to hook it up to your TV. Then comes the inevitable final pitch: "Would you like an extended warranty for that?"

If you've done your homework, you'll just say no. For what is largely an afterthought in the buying process, extended warranties -- or more accurately, service contracts -- have become a huge $15 billion annual business. Typically, at least half of that goes into the seller's pocket as profit, with less than 20% spent on the repair or replacement of products. To put that in gambling terms: The house has set the odds so that for every $100 it takes in, it pays out only $20. You're betting against the house. Guess who wins.

That's why consumer organizations by and large counsel against service contracts. "We basically urge people not to buy extended warranties," says Ken McEldowney, executive director of Consumer Action, a San Francisco watchdog group. "The worst ripoff is on appliances, because they have gotten so reliable."

Consumer Reports, the nonprofit product-testing magazine, generally agrees that such warranties aren't worth the money. But in its January issue it cites four products for which they might make sense: treadmills and elliptical trainers because of all their moving parts, plasma TVs because they run hot, and laptop PCs. Even so, the magazine admits that it's relying on a calculated hunch for the first three. "We don't have the data on three-year-old exercise equipment or plasma TVs," says deputy editor David Heim. For laptops, its survey of owners shows that 33% fail within three years. And it recommends buying the contract directly from the manufacturer rather than a retailer.

If you're offered an extended warranty, here's what to consider before you buy:

How likely is this equipment to break?

Most major appliances either fail in the first year because of defects in manufacturing, when the maker's warranty is still in effect, or after five years, when the extended warranty has expired, as appliance parts wear out.

How much will it cost to replace?

Best Buy charges $49.99 for a four-year contract on a Magnavox DVD player that sells for $39.99. Enough said.

What will it cost me to repair it on my own?

Consumer Reports figures that a vacuum cleaner or lawn mower can be repaired for two-thirds of the cost of a three-year contract. Britain's Office of Fair Trading discovered that consumers pay as much for a five-year contract on a clothes washer as it would cost to repair it four times.

How long am I covered by the manufacturer?

Most factory warranties cover a year of parts and labor. So the first year of a three-year extended warranty is wasted. And how's this for outrageous: CompUSA charges $17.99 for a two-year replacement policy on a $59.99 Netgear Inc. (NTGR ) wireless router for home networks -- even though Netgear's warranty will repair or replace it free for three years.

Which credit card should I use?

Many card issuers double the manufacturer's warranty for free. If you decide that paying a premium for a peace of mind is worth it, shop around, even after the fact. You don't have to buy the contract from the retailer, and you don't have to buy it when you buy the goods -- you usually have 30 days from purchase. Check with the manufacturer, which often will offer a better deal. For a Satellite laptop PC that sells for just under $1,000, Toshiba Corp. (TOSBF ) charges $199 for a three-year plan that also covers such accidental damage as dropping the laptop or spilling a Coke on the keyboard. CompUSA wants $369.99 for the extended warranty alone.

If you've already bought a warranty and you're having second thoughts, most states require the seller to give you a full refund if you change your mind within 30 days. At least that's something no casino would allow after you've placed a sucker bet.

By Larry Armstrong in Los Angeles

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