Vehicle Service Contract: Everything You Need to Know

Written by Zach Shefska

Zach Shefska is Chief Executive Officer of Your Auto Advocate. Zach co-founded Your Auto Advocate in 2019 after convincing his then retired father (sorry, dad) to join him in an attempt to make the car buying process more confidence-inspiring and consumer friendly.

November 4, 2020

Vehicle service contracts are fairly simple to understand. They’re a contractual agreement between you (a car owner) and a third party (called an administrator). What value do you get out of a vehicle service contract as a car owner? The administrator promises to pay for certain repairs or services for your vehicle for a set period of time (or distance travelled) as outlined in your contract.

A vehicle service contract is nothing more than that; a promise between two parties, that describes how and when the administrator will pay for certain repairs on a vehicle. Notably, a vehicle service contract is not an extended warranty. We’ll get into the differences between the two down below.

We wrote this guide to try and demystify one of the most frequently sold products in the automotive industry. As you probably know by now, car dealerships do not make their money selling vehicles, they make their money selling ancillary products. Vehicle service contracts are frequently sold to car buyers, and are high profit margin sales for dealerships. That being said, it is of the utmost importance that you understand what vehicle service contracts are (and what they are not), so that you can make an informed decision.

Without further ado, let’s dive in.

Vehicle service contract vs extended warranty

Let’s begin with the most common misconception in the automotive industry; that you can purchase an extended warranty for your vehicle from a third party. You cannot. Believe it or not, there is actually no such thing as an “extended warranty” for a car, truck, or SUV that comes from a third party (not the manufacturer or the dealer).

The term “extended warranty” is used colloquially by third party companies, but technically it does not exist. A warranty is something that comes with the purchase or lease of the vehicle. It can be given by the manufacturer (most typically) or the dealer, but it is an incident of the sale. Warranties are express (the vehicle conforms to a written statement like this vehicle has a new transmission) or implied (warranty of merchantability or fitness for a particular purpose such as if the dealer knows the customer will use it for commuting). 

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If a customer pays for extended coverage, that is a vehicle service contract. Under Magnuson Moss, if a dealer sells a vehicle service contract to the customer within 90 days of sale, the dealer cannot disclaim implied warranties. In approximately 38 states, a dealer can otherwise disclaim express and implied warranties. It does so on the Used Car Buyers Guide and in the RISC or lease agreement. 

All that being said, the term “extended warranty” is used incorrectly to refer to a vehicle service contract.

Route-66-Extended-Warranty-Car-Coverage

Here’s a great example from a company called Route 66 Extended Warranty. On the homepage of their website they make it clear they sell long term vehicle service contracts, not extended warranties, but their name has “warranty” in it. This is a frequently used tactic that can mislead car buyers.

The-Do’s-and-Don’ts-of-Purchasing-a-Vehicle-Service-Contract-

Here is another great example of a vehicle service contract company covering their bases by making it clear they sell VSCs and not extended warranties.

What does this mean? It means vehicles can (and do) have warranties. Those warranties most commonly come from manufacturers. For example, Kia offers a 10-year/100,000 mile limited powertrain warranty on new vehicles. If you’re then being sold an “extended powertrain warranty,” look at the fine print to confirm it is coming from either the dealer or the manufacturer.

If it is a third party, know that they are not selling you an extended powertrain warranty, they are selling you an extended service contract that covers the vehicle’s powertrain. There is a difference between the two. You’ll know it’s a third party if the name on the contract isn’t the dealership’s or the manufacturer’s company name.

Here’s a great example of a legitimate extended warranty and a vehicle service contract from CarMax. CarMax is the world’s largest used car dealer, and they offer a 90 day or 4,000 mile warranty on all of their vehicles. That is an honest to goodness extended warranty. They then offer long term vehicle service contracts. See the screenshot below.

Warranty-and-MaxCare-Extended-Service-plans-at-CarMax

And here is yet another example of a legitimate extended warranty from Mercedes-Benz.

mercedes benz extended warranty brochure

As you can see, this extended warranty actually extends the manufacturer’s warranty on the vehicle. Unlike a third party vehicle service contract, the manufacturer’s extended warranty is an extension of the warranty.

Are vehicle service contracts worth it?

Now that we know the difference between a vehicle service contract and an extended warranty, the question is, are vehicle service contracts worth it? To answer this question we need to break down the two different types of vehicles (new and used), and we also need to discuss how vehicle service contracts are priced.

How vehicle service contracts are priced

No two vehicle service contracts cost the same amount of money. This is because vehicle service contracts are “rated” (an industry term for priced) based on the vehicle identification number (VIN), and the mileage of the vehicle.

Each administrator has a different formula for how they calculate their prices on vehicle service contracts. Just like an insurance company, administrators have entire teams devoted to developing their pricing models. Administrators are in the business of monetizing risk. The administrator needs to charge enough for their product that in the off chance a claim is made against the contract they’ll be able to still make money.

That being said, it’s important to understand that different vehicles fall into different categories or “classes” for pricing. For example, a brand new Toyota Camry will be rated as class 1. A vehicle service contract for this vehicle will be really cheap. However, a vehicle service contract for a used BMW i3 will be incredibly expensive, because the i3 is a class 9 vehicle (the highest on many administrator’s scales).

Each product an administrator sells is priced according to how much risk they are taking on. As a car buyer, and as someone who is interested in purchasing one of these products, it’s important you understand that.

Vehicle service contracts for new vehicles

With pricing out of the way, the question becomes are vehicle service contracts worth it for new vehicles? The TLDR is; it depends on your risk tolerance.

Any vehicle service contract you are offered is inclusive of manufacturer warranties. What does this mean? This means that vehicle service contracts do not replace, nor extend a manufacturer’s existing warranty on a vehicle.

With that in mind, why then would you buy a vehicle service contract, if the manufacturer warranty is already in place? There are two reasons:

  1. The vehicle service contract will cover other things outside the scope of the manufacturer’s warranty; and
  2. The vehicle service contract is priced according to the amount of risk the administrator is taking on (meaning that vehicle service contracts for new vehicles are generally very cheap).

Let’s unpack both of these two reasons why you should consider getting an extended vehicle service contract on a new car.

First, it’s important to understand that many administrators offer perks with their service contracts to make them more appealing to new car owners. For example, trip interruption coverage, rental car reimbursement, and 24/7 roadside assistance are generally all included in a vehicle service contract. These are perks that are typically not included in a manufacturer’s warranty.

Since the new vehicle is covered by the manufacturer’s warranty, administrators are able to price their new car vehicle service contracts more cheaply. Unfortunately, for consumers, most dealers add incredible mark up to these products, so you’d be hard pressed to consider them “cheap” when you’re sitting in the finance and insurance office at the dealership, but know that most new car extended service contracts only cost a few hundred dollars wholesale.

At the end of the day, if you’re able to negotiate a fair price on a vehicle service contract for a new car, it can most certainly be worth it. Would we recommend spending thousands of dollars on a vehicle service contract for a new Toyota Camry? Absolutely not! The value simply isn’t there. However, if the same contract is offered to you for less than a thousand dollars, then it could represent a value to you. Purchasing a vehicle service contract on a new car is entirely up to you and your risk tolerance. And, as always, read the contract before you sign!

Vehicle service contracts for used vehicles

Similar to new cars, service contracts for used vehicles are priced according to how much risk the administrator is taking on. That being said, service contracts for used vehicles are the same “value” as they would be for a new vehicle.

It is important to understand that if the used vehicle you are purchasing has existing manufacturer warranties in place (for example the vehicle you are buying has 25,000 miles on it, and the manufacturer warranty cover up to 36,000 miles), then the vehicle service contract is inclusive of that existing warranty (just like what we discussed above with regards to new cars). For clarity, this means that the service contract does not extend the manufacturer’s warranty, instead it exists in conjunction with the manufacturer’s warranty.

It is of critical importance that you read the contract carefully before signing for a vehicle service contract. In the contract you will see what repairs the administrator excludes. The last thing you want to do is sign up for a service contract, only to go to the repair shop one day and have to foot the bill because what broke wasn’t covered.

The most common reasons why people don’t buy vehicle service contracts

Now that we’ve discussed if vehicle service contracts are worth it or not, it’s important that we spend some time being brutally honest about why people DON’T buy these types of products.

There are a few common reasons why people don’t buy vehicle service contracts. Research from Assurant Solutions sheds light on the most common reasons why people avoid paying for service contracts.

Reasons for Not Purchasing a Vehicle service contract

If your existing vehicle is already covered under the manufacturer’s warranty that is a good reason to not buy a vehicle service contract. Like we discussed earlier, at that point it’s all about your personal risk tolerance.

29% of respondents said that vehicle service contracts simply weren’t worth the money, which makes a ton of sense. Dealerships typically markup their vehicle service contracts by 200 or 300%, meaning what would cost them $300 to buy wholesale is being sold to you for $1,000 or more.

This ties in with the third reason why people do not purchase service contracts, they’re simply too expensive.

What does reddit have to say about vehicle service contracts?

Reddit is a trusted source for unbiased advice from other people. So what does reddit have to say about vehicle service contracts? An ex-mechanic posted a lengthy response to a reddit thread about vehicle service contracts.

Some of the highlights from his post include:

  • Read that extended warranty carefully, many exclude so many items that it is a ripoff. Engine bearing and core component failures are exceptionally rare now.
  • Many of the newer cars out there may in fact be the best candidates for an extended warranty. Sketchy ultra light high horsepower cars are begging to break parts.
  • If you are buying something with a turbo (turbo engines like ecoboost are stressed and beg for abuse), something that was beat on and abused, or a higher end luxury car it may well be worth your while to get the warranty.

Note that the user is referring to vehicle service contracts as extended warranties. As you know from reading above, these contracts are not extended warranties, however many people call them that. That being said, their advice spot on.

Vehicle service contract companies

If you are considering purchasing a vehicle service contract, where should you buy it? Our recommendation would be that if you are going to buy one from a dealership, you negotiate the price of it.

As mentioned before in this post, these products (and other finance and insurance products) are typically marked up considerably before being sold to a car buyer. Please do not feel pressured to buy a vehicle service contract at the dealership, and know that if the dealer is telling you that you “have to buy the extended warranty to get the car deal,” or anything along those lines, they are behaving in a misleading (and illegal) way. Most third party administrators allow up to 60 days from the date of purchase of the vehicle to purchase a vehicle service contract. This means you have two months from the date you purchase your vehicle to purchase extended coverage. Don’t feel pressured or obligated to make a decision on the day you buy your car at the dealership.

There are a handful of direct to consumer companies that sell vehicle service contracts, and the odds are you’ve heard their informercials, received phone calls from them, or gotten a written letter saying “your vehicle isn’t covered, get our products!” Those companies may offer fine products, but we strongly recommend you review Better Business Bureau reviews for any company you are considering.

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1 Comment

  1. Tom Dubois

    Many years ago I purchased an “extended warranty” on a new car. After receiving the warranty document, I was surprised (my fault because I didn’t read the contract completely in advance) to learn that the “warranty” terms required service intervals that were in excess of the manufacturer’s service recommendations. For example, it required a change of transmission fluid and filter every 10,000 miles which far exceeds service requirements even under the most severe operating conditions. It became obvious to me that if I were to scrupulously maintain the car according to the “extended warranty,” there would never be a need for repair. I, on the other hand, would be shelling out money for needless maintenance which would completely obliterate the potential savings that a “warranty” was to cover.

    Reply

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