No, home warranties are not worth it. Home warranties are forced savings for people who don’t have the self-discipline to save. Items that predictably wear out from normal use are not good applications for insurance. 

Good Insurance

There are two kinds of insurance in this world, good insurance and bad insurance. Good insurance is relatively inexpensive and it covers tragedies which are highly unlikely to occur, but if it did you would be completely wiped out. An example of good insurance is homeowners insurance. If you own a home and have a mortgage, you have homeowners insurance. 

Homeowners insurance covers calamities such as fires, earthquakes, floods, tornadoes and hurricanes (depending on the policy). It’s relatively inexpensive considering how much it pays if you have a claim. 

On average, homeowners insurance costs about $100 per month. If your home burns to the ground, the insurance company is on the hook for the home’s entire value. Homeowners insurance is inexpensive because there is little risk that something like that will happen to you. Do things like that happen? Sure, every day. But will they happen to you? Highly unlikely.

Bad Insurance

Bad insurance is just the opposite. It costs a lot and pays very little. A home warranty is an example of bad insurance. Home warranties cost anywhere from $300 - $900 per month, yet if you have a claim they don’t pay anywhere near what homeowners insurance would pay if your home burned down. Home warranties come with numerous deductibles, limitations, and exclusions. Chances are, if you have a home warranty and you file a claim, you will be disappointed with the results.

Is there something illegitimate or untoward going on here? No, not at all. Home warranties are perfectly legit and people who buy them get exactly what they signed up for.

The items typically covered by a home warranty include major appliances like refrigerators and washing machines as well as a home’s heating and cooling system and water heater. The useful lives of those items are well-documented. It’s not a mystery if your heating and cooling system stops working after 15 years, or your washing machine conks-out when it is 10 years old.

What is Insurance?

Let’s step back for a moment and examine the basic concept of insurance. What is it? In the simplest terms, insurance is a group of people pooling their money together to cover the cost of something catastrophic happening to one of them. Insurance exists so that a person with the misfortune of experiencing a major calamity does not have to pay for it all by themselves. 

Insurance performs well when the risk is low and the potential damages are high. Like homeowners insurance. The low risk drives down the cost making it affordable for everyone. Conversely, when the risk is high and the damages are low, insurance performs poorly. Like a home warranty. The premiums get pricey and you don’t get as much bang for your buck.

As we said at the outset, home warranties are essentially forced savings for people who cannot save on their own. If you set aside an amount of money equal the typical home warranty premium each month, you should have more than enough to replace household items when they wear out.

Self-Insurance vs. Home Warranty

The concept of self-insurance is nothing new, in fact we do it every day. Most anything that you pay out of your pocket instead of going through an insurance company is a form of self-insurance. 

Here’s a question: do you ever get hungry? Sure you do, everyone does. Do you have hunger insurance? No, that would be ridiculous. When you get hungry you go to the store or a restaurant and you get something to eat.

It’s the same with owning a home. Every day you use the items in your home and it is perfectly natural for them to wear out. It’s predictable, like getting hungry. You don’t need to insure against things that are totally predictable.

Insurance Companies

Insurance companies are in business to make money. If they don’t make money, they go out of business. How do insurance companies make money? By taking in more money than they pay out.

On top of taking in more than they pay out, insurance companies take in enough to pay for all of their business expenses. Like television commercials, office buildings, and the salaries of everyone who works for them. The CEO alone makes more money in a year than most people make in a lifetime.

If insurance companies have enough money to pay for all that, doesn’t it make sense that you are better off insuring yourself? You get to keep the extra money that would have gone to pay for the insurance company’s advertising and payroll and other costs.

Closing Thoughts

With the exception of insuring against low risk/high damage disasters like those covered by homeowners insurance, you are usually better off insuring yourself. You don’t need a home warranty. Take the money you would have spent on a home warranty and put it in the bank. You will have more than enough to maintain your home and with what’s left over you can go on a nice vacation.

Photo credit: Pixabay The Eggstack Blog will never post an article influenced by an outside company or advertiser. Our mission is to help you overcome uncertainty about retirement planning and inspire confidence in your financial future.