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My truck is currently financed with $31k owing @ 9.9% interest over 72 months = $565/month

I've been approved to refinance my vehicle with the following
$31k owing, down payment of $3.5k & 5.9% interest over 84 months = $27.5k owing @ $400/month

I'm thinking of either changing the term to 60 months ($530/month) OR keep the term but kick in (penalty free) extra payments equalling $530/month.

Is there a smarter approach or is it a wash?

The security I see in the second option is that if for some reason I can't make the $530 payment one week, I can still pay the $400 and not be in trouble.

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It really depends on the answers to two questions:

1) How tight is your budget going to be if you have to make that $530 payment every month?

Obviously, you'd still be better off than you are now, since that's still $30 cheaper. But, if you're living essentially paycheck to paycheck, then the extra flexibility of the $400/month option can make the difference if something unforeseen happens.

2) How disciplined (financially) have you proven you can be?

The "I'll make extra payments every month" sounds real nice, but many people end up not doing it. I should know, I'm one of them. I'm still paying on my student loans because of it. If you know (by having done it before), that you can make that extra $130 go out each and every month and not talk yourself into using it on all sorts of "more important needs", then hey, go for it. Financial flexibility is a great thing, and having that monthly nut (all your minimum living expenses combined) as low as possible contributes greatly to that flexibility.

Update: Another thing to consider
Another thing to consider is what they do with your extra payment. Will they apply it to the principal, or will they treat it as a prepayment?

If they apply it to principal, it'll be just like if you had that shorter term. Your principal goes down additionally by that extra amount, and the next month, you owe another $400.

On the other hand, if they treat it as a prepayment, then that extra $130 will be applied to the next month's bill. Principal stays the same, and the next month you'll be billed $270.

There are two practical differences for you:

1) With prepayment, you'll pay slightly more interest over that 60 months paying it off. Because it's not amortized into the loan, the principal balance doesn't go down faster while the loan exists. And since interest is calculated on the remaining principal balance, end result is more interest than you otherwise would have paid. That sucks, but:

2) with the prepayment, consider that at the end of year 2, you'd have over 7 months of payments prepaid. So, if some emergency does come up, you don't have to send them any money at all for 7 months. There's that flexibility again. :-)

Honestly, while this is something you should find out about the loan, it's really still a wash. I haven't done the math, but with the interest rate, amount of the loan and time frame, I think the extra interest would be pretty minor.

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  • thanks again @patches. So interest and cost wise, it's a wash if I'm disciplined in making the $530 monthly? – Chase Florell Mar 3 '12 at 4:19
  • @ChaseFlorell if the interest rate's the same, and the extra payment is amortized into the loan, yes. Hmm... I typed a big long explanation of what I meant with that second bit, then realized it'd be better to update my answer with it. I'll do that directly. – Patches Mar 3 '12 at 4:47
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Refinancing a car for anything other than lowering the rate is not a good idea. Keep the same term, or take a shorter one.

Remember that unlike real property, a car only loses value.

So when you make your payments on your 84 month (!) loan, those payments are amortized so that the interest is front loaded. The problem is, when your car gets totalled around month 24, insurance will generally only pay what the car is worth, and you'll owe more.

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  • The insurance comment is correct unless you pay for total replacement insurance. – Chase Florell Mar 5 '12 at 1:40
  • @ChaseFlorell Total replacement coverage (often in the guise of collision coverage and comprehensive (non-collision) coverage) is essentially impossible to get in the US, but maybe things are different in Canada. Almost all collision coverage has a deductible (sometimes as low as $50) and gets very expensive as the car gets older. Furthermore, as duffbeer703 says, the insurance pays for what the car or truck is worth, that is, replacement is not with a brand-new truck but with a truck of comparable current value, or the equivalent in cash, not your original purchase price. – Dilip Sarwate Mar 5 '12 at 2:25
  • Maybe it's different in Canada. I've written off a truck before (50% fault) and was delivered a brand new truck the next day. No deductible. – Chase Florell Mar 5 '12 at 2:56

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