With the rise of online price-checking, the profit margins on new cars have fallen dramatically over the past ten years. In 1995, the average markup on a car was almost 17%. As in, if you paid $39,250 for a new vehicle back then, approximately $25,000 covers the dealer’s cost of purchasing the vehicle from the manufacturer, and the remaining $4,250 represents the dealer’s cut in the transaction for getting you the vehicle.
Because people comparison shop and prioritize the cheapest price over nearly everything else, profit margins in the sector have fallen to 2.8% in 2017. That is a punishing drop in profits. A similar transaction with a $25,000 base would only deliver $700 in profits to the dealership on cars that cost $25,700 pre-tax to purchase.
As is typical with industries whose business models are in transition, car dealers have sought ways to recoup the lost profits from the rise of internet comparison shopping, and they have turned to extended automobile warranties to offset their lost profits from the sale of the car itself.
It has gotten so bad that many car dealerships won’t compliment a dealer on making a car sale unless an extended warranty is purchased as well. This occurs because extended car warranties are the new easy money for dealers.
Usually, a car warranty will require you to make monthly payments in the $200-$400 per month range in exchange for coverage in years 4-10 of your vehicle ownership. The average amount of car repairs that are incurred during this period total around $7,800 while the average amount expended in auto warranty premiums averages $23,400. For the typical user, you will be paying roughly triple the amount of money in premiums that you will get back in repairs.
Now, of course, these warranties do serve a useful purpose because those $2,000-$5,000 car repairs do show up at inopportune times (is there ever an opportune time?) and if the studies on America’s savings rates are any indication, the typical American does not possess the liquidity to come up with these large one-time cash payments.
But the terms, at present, are so horrendous that it is wise for customers to self-insure by saving up money in a side account to pay for their own car expenses as they become due. If you put $300 in a savings account per month after you buy a new car, and rely on the new car warranty that typically covers the first three years, then you will have saved $10,800 entering year four. Statistically, the average car buyer could save up enough funds in three years to cover the expected cost of repairs in years 4-10 just by saving up the amount themselves instead of shipping off $300 to pay for an extended car warranty each month.
Extended car warranties are a sector of the economy where you will see some rationalization in the next decade, perhaps forcibly so in the context of self-driving cars. But as things stand now, car dealers do not have offer favorable warranty terms that justify the bargain. Self-insuring may sound impractical to many because it requires the self-discipline to ignore money that you can easily access by respecting the silo of the segregated account that you create, but it behooves the typical car buyer to develop that discipline because the single decision can save tens of thousands of dollars.
I understand that companies that specialize in extended car warranties, such as Endurance and CARCHEX, offer cheaper warranties than what you will encounter at the dealer. Their profit margins are about one-third less than what the dealerships demand, such that you will only be paying double the value that you receive with online warranties compared to triple the value that is customary in the dealership context.
Unless you’re getting an extended car warranty through USAA or some type of credit-union or association in which you are member, the costs of an extended car warranty are guaranteed to be much higher than the value that you will receive. I understand that this is the purpose of insurance–the warranty company relieves you of the liquidity hit involved with unexpectedly large payment obligations to resolve car repairs–but the cost of that benefit in the marketplace today is too high. Saving the money for yourself in a side account leads to a dramatically superior outcome compared to shoveling your wealth away to the manufacturer or dealers as part of an extended car warranty plan each month. It’s a no-brainer.