The Psychology of Extended Warranties

Written by Dr. Richard Osbaldiston

As a consumer, you have probably been asked if you want to purchase an extended warranty.  Nowadays, these warranties can apply to everything from pretty small items (like blenders or power tools) to major purchases (like refrigerators or cars).

The purpose of this blog is not to answer the question “Should you buy the extended warranty?”  Rather, the purpose of this blog is to think about the psychology behind extended warranties.

The first step is to think about the big picture.  Extended warranties are sold by companies—and every company’s primary objective is to make money, generate profit, and stay in business.  So if someone is selling you something, it is most likely that they are making money on it.

If a company is selling an extended warranty for a new car for $500, then that means that company is betting over the long haul and over thousands of consumers that it will pay out less than $500 per repair expense.  There may be some repair bills that cost more than $500, or even more than $1,000, but on average, the repair bills will be less than $500 per car.

The company has the good fortune to be able to look at the big picture and the long run.

The second step is to think about the tiny picture—that’s you, the buyer.  If you are buying a $25,000 automobile, it might give you years of good service, or it might be a lemon.  You have no way of knowing which way it will go, but you are hoping it will be a good vehicle.  But you’d like to protect yourself against getting a lemon. 

This is where the psychology comes in.  People are different in how they perceive risks.  Some people are “risk averse,” that is, they don’t like to take risks.  They’d rather pay a little more to know that they are covered against a big loss.  To risk-averse people, paying $500 to know that they won’t have to pay $1,000-$2,000 for a major repair just makes sense to them.

However, other people are risk-seeking or risk-loving.  They are willing to take risks.  To them, they’d rather save the $500 and take a chance that the car will be just fine.  If there is a big repair bill down the road, they’ll deal with that when the time comes.

Next time some offers you an extended warranty, the question to ask yourself is “Where do I fall on the risk scale?”  If you fall near the risk-averse end, you may be more comfortable buying the warranty.  But if you fall near the risk-loving end, you will be more comfortable declining the warranty.  Like most things in psychology, neither option is right or wrong.  It just depends on how you see the situation.

Published on November 05, 2013