Hi. Todd Ortscheid here with GTL Real Estate. Today I wanted to talk about home warranties. This is a pretty common question we get from everybody we deal with, not just with landlords but also with just homeowners in general who are wondering whether it makes sense for them to get a home warranty for a property that they've just purchased, whether they're going to rent it out or live in it themselves. This is always an important topic.
So the first thing is, if you're buying a house that you're going to live in, it does make sense to request a home warranty from the seller. That's usually something that you can get thrown in, just to get the deal closed. That's pretty common. Not an unusual thing to get a year or two of home warranty covered by the seller. So that's a good thing to get. It's not costing you anything so that's something we would recommend if you're making an offer on a purchase for a house you're actually going to be living in yourself.
Now it's a different question, though, when you're talking about a rental property because you're not the one that's going to be living there. You're going to be having a tenant that you want to, of course, be a happy tenant, someone that's going to keep renewing their lease to keep your cost down. And so you can keep raising the rent and improving your margins. It's a different story then because you want to make sure that the repairs are getting done to keep that tenant happy. You want to look at these situations differently as to what might make sense for a rental property as compared to an owner-occupied property.
Generally, we do not recommend that you have a home warranty on a rental property. Now there's a whole bunch of reasons for that. First among them, of course, is just finances. I say it makes sense for you when you buy a property to get the seller to pay for a home warranty, but of course, that's different than you paying for it. When the seller's paying for it, it's no out-of-pocket for you. It's probably not affecting the purchase price of the property at all. You probably got them to throw it in as a sweetener just to get the sale done, so it's not costing you anything.
When it comes to buying it for a rental property though, you're going to be paying for that yourself. So the question is, is it cost effective? And just like any form of insurance or extended warranty on a car, any of those sorts of things, what the insurance company is making money on is the spread between what the cost of the repairs actually are and what they are charging you for your premiums and deductibles. All that money in between there is what they're making their money on.
By default, what that means is, you're paying more over the long haul for the repairs on your property. You're just spreading it out and paying it in yearly and monthly installments instead paying for it as the actual repairs come up. The other thing is, you're paying for the warranty company's overhead. Obviously they have their expenses since they're a middleman between you and the vendors who are doing the work and they also have their profit margins so they probably want a profit margin somewhere in the 8, 10, 12% range.
When you're paying your premiums and your deductibles, it's going towards the vendor's cost to fix your property, the warranty company's overhead, and their profit margin. When you add all that up, you're paying a significant premium over what it would have cost you to just pay to have the repairs done yourself.
Now this can make sense. There are times this actually does makes sense. If you're a homeowner, maybe you're an accidental landlord. You had to move out of town. Maybe you had a military transfer and you had a last-minute move out of town. You couldn't sell your house, you want to rent it out, and you don't have a lot of savings. If you had to do a $3,000 HVAC repair, for example, maybe you don't have enough money in savings to cover that and it would completely wipe you out. So if that's the case, then it does make sense to get the home warranty.
But that's generally the only time it makes sense to get the home warranty. If you have any way to pay for that repair, whether it's out of a savings account or maybe a 401K loan or whatever the case may be, you're probably better off paying for those repairs yourself as they come along, rather than paying for the home warranty and paying that premium that's going to cover everything for that middleman in the warranty company. So it just doesn't make financial sense. That's the biggest reason that we don't recommend home warranties.
The other thing is, home warranty companies are slow. When we call in a home warranty repair, usually it takes them a couple days to get that scheduled. Then it takes a couple days for the vendor to get out to the house. Then they want a couple days to get parts. So it all starts adding up and by the time it's all said and done, usually a week to two weeks have passed before the repair has actually been accomplished.
Now in the meantime, as you can imagine, the tenant's not very happy about this. So the tenant has probably been renting apartments or other houses before. They're used to having repairs done in the most part within two, three days. That's about average what it takes to get a repair done when you're not dealing with a warranty company.
So now they rent your house and you have a home warranty and they're seeing that whenever they call in a repair, they have to wait a week to a week and a half to get that fixed. That makes them pretty unhappy because they know as a renter that that shouldn't take that long. The only reason it's doing that is because of this warranty company.
And, of course, they're also having to deal with calling the warranty company or the warranty company's vendor, they're having to schedule with them. It's not a very easy process like it is if they're just dealing with us and having our vendor go out.
It's all a situation that comes together to make the tenant very unhappy. Now unhappy tenant, of course, there's two things that go along with that. Number one, an unhappy tenant is more likely than a happy tenant to call in a lot of repairs. So something that a very happy tenant might have overlooked and said that's a minor issue, I'm not going to bother the landlord with that.
If they're unhappy because of how long it takes repairs to get done, they might say, you know what, I'm going to start calling in every single little issue just to show this landlord. That means even though you're only paying say a $75 deductible for each one of those service calls through your warranty company, you're paying a lot of them because that tenant's calling in every little thing they can think of just to get back at you because of how long it's taking you to get the repairs done. So that adds up.
And then of course the tenant gets angrier and angrier as each one of these repairs takes so long to get done. Then when it gets to the end of their lease, here's the big problem: they don't want to renew. Because they're thinking, I can go down the street and rent a property from another landlord who doesn't use a warranty company and then when I have a repair, it gets done in two or three days.
That's something you don't want to happen because turnover is your number one cause of lost money in rental properties. It's all about turnover. So if you have tenants leaving frequently then you have vacancies, you have extra repairs, you have leasing fees that you're paying to real estate agents to find you new renters. So all those expenses and that lost revenue add up.
You hear me say it in these videos all the time. It's all about reducing tenant turnover because that's where all of your costs are. You don't want an angry tenant because they're not going to renew their lease.
The other thing, of course, is you also have other expenses that come into this. If you're using a management company, most management companies, including us, charge a premium on our management fee to manage a home warranty company just because of how much work it is. The warranty company almost never just sends someone out and makes it a really easy situation. Instead we usually spend hours on the phone trying to get the warranty company to get somebody out there and actually get the work done.
Because of that we have to charge extra for dealing with the warranty company so your management fee gets bumped up. Most management companies will do that. They'll either charge extra on your management fee or they'll charge a premium on each repair. So they might charge you, say, $100 flat fee every time they have to call in a home warranty repair.
Most management companies are doing this in one way or another to make up for all the hassles associated with a warranty company. So that's another increase to your costs. When you start adding all this up, it gets pretty expensive over the long haul to use a home warranty. We definitely don't recommend that.
You might be asking, what are the alternatives then? If I don't use a home warranty, what are the best ways to take care of these repair expenses? There's a couple different ways that we recommend you might do this. The first is, you could just take the money that you would pay the home warranty company and set that aside. You probably got a savings account with your bank where you have your checking account. If you were going to pay $500 for a home warranty, take that $500 instead and put it in that savings account. Then take what your deductibles would be if you were having repair bills, take those and put those into that savings account also.
You can estimate a service call every couple of months on average, so every other month just take that $75 or $100 that you would have paid in deductibles to the warranty company and put that into the savings account. In the long run, this is actually going to net you more money than if you had used the actual warranty company because you're going to end up saving some money. That's one way to do it.
Another way to do it is to just take a percentage of your rent income and just set that aside. This is what I do with my own rental properties. I just take 10% of the rent that comes in on that property and I set it aside to be used for repairs. That's a good estimate of what your repairs over the long haul are going to be. That's another way to do it.
Finally something we could do for you, is we could just escrow the money for you. You could just tell us, increase my escrowed money in my account with the management company by $100 every month, for example. We can just set that money aside in your account to be used if any repairs come up.
Those are a few different ways you can deal with it to make sure you have that money set aside so you're not just paying out a big repair bill on your credit card or whatever it may be when the repair comes along. If that's something you want to do, just talk to us and we can work that out and try to help you out with that.
Bottom line is, you're better off financially without the home warranty and you're definitely better off if it's a rental property, keeping your tenant happy without that home warranty. We strongly recommend that you don't use a home warranty company. If you have any questions and you'd like to talk to us about it you can send us an email at firstname.lastname@example.org and we'd be happy to answer any of those questions for you.