What is a home warranty?
A home warranty is essentially an insurance policy either for essential systems of your house (like heating, cooling, or hot water), or essential appliances of your house (like fridge, stove, washer, and dryer) or both of them. Note that only systems and appliances specifically mentioned in your policy are covered. In a sense home warranty is the complement of home insurance which covers property damage, loss, theft, and liability. Unlike home insurance whose premium depends on the value, size, type, location, and claim history of your home, a home warranty is normally sold for a fixed amount of money independent of the detail of the house. Home insurance typically covers unpredictable, rare, and very costly events, while a home warranty covers partly predictable, common but not too costly events.
The justification for home insurance is obvious, as it protects us against incidents that might bankrupt us or at least materially reduce our net worth. What about a home warranty, it would be quite possible for most people, or at least for most homeowners to repair their HVAC or their fridge without much effect on their net worth. Does this mean buying a home warranty is not worthwhile?
Well, most commonly the topic of a home warranty comes up when you are buying a home. The seller might offer to pay for your home warranty. Sellers (whether builders or people who are reselling their homes) would like to alleviate your worries about all that might go wrong with your home. This would allow them to increase the chance of a successful sale. Also, they would reduce the possibility of buyers calling them and complaining about problems that they learn about after closing the deal.
How valuable is a home warranty?
But do home warranties provide peace of mind? Well not necessarily. Some of the most serious and costly issues that can happen to your home are problems like an uneven settling of your foundation, bowing of your basement walls, or leaking of your roof which is not covered by a typical home warranty. When it comes to systems or appliances which are covered by your home warranty if they stop working you should call your home warranty company and incur a service fee which depends on your policy and maybe around $100. They will contact their contractor to come to your home and evaluate the problem. The contractor will make a report about the problem which allows your warranty issuer to decide if the problem is covered by your policy. Most home warranty contracts are written in a way that issues due to normal wear and tear are covered while issues due to improper installation or improper use are not covered.
Unfortunately deciding whether a problem is due to improper installation or improper use or just due to normal wear and tear is a judgment call and creates a gray area. So there is this uncertainty about who is responsible for the cost of repairs in addition to the uncertainty of when a repair or replacement might become necessary. Surely if you are provided with the warranty by the seller free of charge it is worth having.
When deciding if you want to pay for a home warranty out of pocket it is best to consider the cons and pros in more detail.
- You are paying the home premium even if nothing breaks or malfunctions.
- You are paying the service fee for any issue even if the warrantor refuses your claim (for example considering the problem arising from misuse).
- When something expensive breaks down or if multiple issues occur during the same year you could easily reach the ceiling for your warranty and would have to contribute out of pocket.
- You have no choice in deciding who would provide your home with the repairs needed.
- You do not have to spend time chasing contractors.
- Contractors are far more responsive to a warrantor who can employ them day after day than to a homeowner who might need their service once every couple of years.
Looking at the cons and pros lists, we think if you are interested in the workings of systems and appliances in your home and are familiar with the vocabulary describing the workings of them, setting up a house emergency fund would be a better choice. If on the other hand you are not physically present at your home and have rented it out, or if for some reason you are unwilling to engage with the inner workings of the systems and appliances in your home then a home warranty is likely to be very useful.
The value creation of home warranty companies arises from the fact that they can buy services of repairmen and contractors in bulk. Thus they can get a much better rate for repairmen services compared to homeowners. On the other hand, they need to add the cost of running their business and profit for their business to the expected cost of repairmen wages and spare parts to determine the premium they charge for their home warranty policy. So on the balance whether a home warranty is worthwhile or not depends on your situation and also the options available to you.
In large metropolitan areas due to the larger size of the market for home warranty products, several companies are likely to offer this product. The competition amongst these players in the market is very likely to enable you to get a better service. So to make a final decision on whether the home warranty is worthwhile or not you need to compare the coverage different providers are offering and compare it to the annual price they charge. It is also a good idea to ask your friends and family who have used such policies about how the company they dealt with acts about gray areas. That is how the warrantor behaves in cases where an argument can be made about the breakdown being due to misuse as well as it being the result of normal wear and tear.
Another point to consider is that a home warranty suffers from a fundamental issue that is present in every voluntary (non-compulsory) insurance product. In general, each consumer knows much more about their risk profile than does the insurance company. Worth that in many cases it is not worthwhile for the coverage provider to individualize their quote. Thus people with higher than average risk are more likely to buy the policy and this very fact increases the cost of the policy.
Specifically, about the home warranty, this means people whose systems and appliances are close to failing are more likely to sign up for the policy and if you have your house’s systems and appliances in perfect working order you would be subsidizing other home warranty purchasers.