Home Warranty companies are constantly inundating consumers with offers both online and through unsolicited direct mail. What exactly is a Home Warranty? Under what circumstances is it a good idea, and what are your options for repair costs outside of entering into such agreements?

What is a Home Warranty?

Home Warranty contracts are “Service Contracts” for home repairs with very specific limitations. These contracts provide immediate service and repair on existing or “used” home appliances and systems. Home Warranty contracts are NOT insurance policies.

This is an important distinction since “insurance policies”, in general, assume that the holder of the policy derives some benefit. Home warranty contracts are the exact inverse of insurance in that they only cover what no insurance policy ever does – normal wear and tear. These contracts do not provide protection from sudden events or unpredictable perils, such as fire, rain, contractor malfeasance or damage caused by people, pests or pets.

Service Contract Indemnification

Furthermore, most states have passed the Service Contract Model Act that indemnifies service contract companies and reduces the stringent regulations to which insurance companies must adhere. The recent trend has been to exclude Home Warranty service contracts from State Insurance codes. In other words, for most states, service contract companies are NOT under the strict regulatory authority of the State Insurance Commissioner. Florida is the ONLY state, at this time, which treats service contracts as insurance.

Similar to an “extended warranty” that is offered when you initially purchase an item, service contracts are always purchased at an additional cost. The written contracts usually has a coverage term that usually extends for a one year period and can be renewed each year.

Also, like the extended warranty, the obligor (the company offering the service contract) agrees to make repairs or replacements of items covered in the contract. Thus if an item, covered in the contract, fails or becomes inoperable, you may submit a claim to the obligor. The obligor, has contracts with various tradespeople and dispatches a service provider, based on your area and your specific needs. You will be required to pay a nominal service or Trade Call Fee (TCF), similar in spirit to a health insurance “Co-Pay”, as part of your contractual agreement. Thus the $50 TCF for a $1,000 HVAC fix may sound like a smart investment. But is it really?

Home Warranty Coverage and Limitations

First, always make sure to read ALL of the fine print in the contract. It is important that you read and understand the plan’s coverage and limitations. This is where most property owners lose. Home warranty contracts are NOT routine maintenance contracts and only cover items which have failed to operate.

Even further, the reason for that inoperability MUST be the result of wear and tear and not external damage. A review of three of the top five major home warranty contact companies’ contracts over the last four years has revealed that the list of exclusions or items “Not Covered” has grown year after year. Additionally, over a period of four years, one company’s TCF increased by 50% from $50 to $75.

When Is a Home Warranty Contract a Good Idea?

The following circumstances present better suitability to enter a Home Warranty contract:

  • New Home Purchase
  • Recurring Issues with Older Systems
  • Rental Properties
  • Foreclosure Sale or Short Sales
  • Property Sat on the Market for a Long Time
  • Property was Recently Flipped
  • Property is Located Far Away
  • Property is Being Sold

New Home Purchase

Home warranty contracts are usually purchased as part of a real estate transaction, paid for by the seller, to provide the buyer a cost-effective recourse against any non-disclosed home defects. It makes the property easier to sell, as it is added assurance for the buyer should they be concerned about any unforeseen repair issues that may be encountered during the first year of homeownership.

Since the seller is responsible for the contract purchase, the buyer is only responsible for paying the TCF, which can range from $50 to $125 per claim, depending on the contract plan. A home warranty contract with a low TCF (around $75) is a good investment, as long as the item needing repair is covered. A smart move would be to group your claim under one trade. If you can, hold off repair of one fixture and wait until you have three covered electrical issues. In this manner you would only need to pay just one TCF for three service items.

Recurring Issues with Older Systems

Should you discover that the HVAC system or some other large system within your home is close to being at the end of its life, it might be a good idea to invest in a home warranty contract. For less than $500 a year, you can have peace of mind against, air conditioning and heating expenses that may run upwards of thousands of dollars. By purchasing a home warranty contract, you are only responsible for the contract cost and the TCF. The only caveat is that the repairs to the system must fall within the scope of covered items within the contract. This has been an issue of discontent for many home warranty customers. Here are just three example review websites that demonstrate this dissatisfaction:

Another caveat to note is, should your older system require replacement, there may be certain limits to the value of the new system. An example may be, if you own an older, high-end brand appliance, such as a Sub Zero refrigerator, most home warranty contracts will only approve an amount equivalent to a “Builder’s Grade” replacement. In this case, the homeowner would have to cover the cost beyond the approved dollar limit.

Rental Properties

Home warranty contracts are useful for owners of rental properties with little handyman or mechanical skills. Home warranties can also be a time saver, as a property owner can rely on the warranty company to refer a qualified vendor quickly.

Once again, the item covered must be non-functional in order for the claim to be considered valid and the cause of the breakdown must be due to “wear and tear”. Should your tenant be the cause of the malfunction, you may not have a valid claim per the Limitations of Liability section of your contract.

Foreclosure Sale or Short Sales

Properties that were purchased as a result of a Short Sale or Foreclosure are usually rife with issues. If you are fortunate enough to purchase a home for less than the property’s true value, you can imagine that maintenance was likely not front of mind for the previous owner. Basic preventative maintenance such as changing air filters, clearing gutters, and repairing leaks, were likely not performed, as the owner who lost the property was likely conserving cash.

A good basic home warranty plan could alleviate any misgivings a buyer may have, especially if the property is purchased below market value. Consider a home warranty contract as part of the purchase price. Check to see if the newly purchased foreclosed or short sale property has an existing home warranty contract, which can be transferred as part of the sale to the buyer.

Property Sat on the Market for a Long Time

Properties that sit on the market for a long period of time, especially in a seller’s market, do so for a reason. Perhaps the home fell out of escrow after a property inspection, or the buyer discovered some undisclosed defect. For whatever reason, a home warranty contract can serve as added assurance for those items which can be repaired if included in the plan contract. Once again, existing valid warranties can be transferred to the buyer thus obligating the buyer to pay only the service or Trade Call Fee for repairs.

Property was Recently Flipped

Properties which were recently “flipped”, meaning the property was purchased for a short period of time and then sold, are another area of concern for home buyers. There could be many reasons why the previous owner chose to sell a property so soon after purchase: job transfer, personal bankruptcy, divorce or the home’s own internal issues.

While one person’s misfortunes can be another person’s gain, a home warranty contract can provide the peace of mind when purchasing a flipped property. Once again, a home warranty will not cover a complete list of issues, and should be purchased only after a solid, comprehensive home inspection by a qualified, licensed inspector.

Property is Located Far Away

Taking care of a property from a distance is challenging. Whether you own a vacation condo or rental property, a warranty contract could make it easier to handle on-going maintenance repairs. Again, a warranty company’s access to local, quality tradespersons would be beneficial.

Property is Being Sold

As mentioned earlier, a home warranty contract is an attractive benefit to prospective buyers. Research supports that homes that come with warranties sell more quickly and for a higher average price than do comparable homes that do not provide warranties.

What Are Your Options Other Than A Home Warranty Contract?

Home warranty contracts should only be purchased in very specific circumstances and buyers of these plans should proceed with caution. Always read the Limitations of Liability BEFORE purchasing a plan.

If you do the math, basic plans cost upwards of $500 to $600 per year. Each claim that you submit will cost between $50 and $125, depending on your plan. In order for a home warranty plan to make sound economic sense, you would need to have yearly repairs that costs between $550 and $975, assuming you only put in three claims a year.

Furthermore, should you have repairs or claims that are NOT covered or that exceed the Limits of Liability, you will still need to pay the TCF but have no benefit of repair, which will still be out of pocket to you. This last scenario, denial of claims, is becoming more and more prevalent in the market.

Should you determine that home warranty plans contain far too many General Limitations then we suggest starting a home maintenance “slush fund”. A home maintenance slush fund takes many caveats of the basic home warranty into consideration:

  1. You purchase a plan and never submit a claim
  2. You submit a claim that is denied
  3. The cost to repair far exceed the home warranty company’s dollar limit per plan term

We suggest setting aside between $50 and $100 each month for home maintenance repairs. According to a report from Home Advisor, homeowners spend an average of $1,105 on annual maintenance. More than 30% of homeowners were forced to complete an emergency repair at some point during the year (with emergency repairs costing an average of $1,206).

In addition to a slush fund, we also recommend researching companies that offer “Home Maintenance Service Plans” in your local market. These firms appear to be taking a pro-active approach to home maintenance that will help reduce the chances of encountering “emergency repairs”.  You may experience sticker shock from some that cater to larger and more complex properties, but it does not hurt to ask if any of their plans can be catered to your specific needs and budget. In any case, we think this competition or disruption against home warranty companies is a good thing for homeowners.

Here is a sample of companies that offer home maintenance services, each offering a different approach to homecare than traditional home warranty programs:

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