You want to pay off your mortgage fast, and you’re considering velocity banking.
Different things motivate people to pay off their mortgages fast. It could be culture, values or anything else.
The desire is completely normal. But it can also leave you with more unintended consequences.
When emotions drive our decisions, then things like moths, porchlight or anything that promises what we want attract us.
That;s why this complete guide is here to help you cover the entire topic, and by the end of it, you will be more than a pro ready to make the best decision.
What is Velocity Banking?
Velocity banking is a strategy that uses a Home Equity Line of Credit (HELOC) to pay off debts instead of the traditional way of paying from monthly income. Experts claim that velocity banking helps you reduce or pay off your debts faster and minimize the interest you pay.
Velocity Banking vs. Infinite Banking
The idea behind Velocity Banking is to borrow (loan) from your HELOC, all the money you need to pay your bills for the month. Then at the end of the month or when you get paid, you send all your income to your HELOC as payment.
The idea is also called paycheck dumping or paycheck parking.
HELOC uses the simple interest to calculate how much interest you owe. Dumping your entire paycheck into the HELOC reduces your monthly interest payment.
Velocity Banking’s efficiency depends on discipline, paying bills on due dates, and keeping your daily HELOC average balance as low as possible.
Infinite Banking involves the use of a dividend-paying whole life insurance policy. It’s structured to enhance the cash value and issued by a mutual insurance company; to provide a banking function for the policyholder.
In Infinite Banking, the policyholder has a contractual obligation to use the cash value in the policy.
The holder completely controls access to the available cash value and can exercise the right to pay back the loan as fast or as slow as they want.
The efficiency of Infinite Banking depends on the policyholder using it and time. Learning how to use it will also benefit the policy holder’s financial life.
The common theme between Velocity Banking and Infinite Banking is that it provides a banking function to the user of either concept. But the question you should be asking is that, is there a way you can improve your financial efficiency by either of the ideas?
Velocity Banking vs. Extra Payments
The essence of Velocity Banking is that you pay off your mortgage faster by making extra payments. But instead of making the extra payments on an existing mortgage, you swap out the mortgage for a HELOC.
The main advantage of Velicity Banking is that using HELOC over a typical mortgage lowers your interest rate, builds equity, and you can take your money out if you need it.
But maybe you are wondering…Does velocity banking work?
How does velocity banking work?
Here is a traditional or simple Velocity Banking example.
Let’s say you have a mortgage of $100,000 at 5% APR and an income of $4,000 per month. You also spend $3000 on miscellaneous expenses, including your monthly mortgage repayment. You’re left with discretionary cash of $1000 every month.
Then, you decide to use the velocity banking strategy and open a HELOC with a credit limit of $25000 at 5% APR (based on your appraised home value of $125,000).
Here is how velocity banking will work for you.
- First, you make a lump sum payment from your HELOC to the mortgage. You can transfer the entire $25000 from HELOC, but it’s wise to keep a reserve. Let’s say you only draw $12,000 on the HELOC to start.
- Your mortgage and HELOC balance becomes $88000 and $12000, respectively.
- Take your monthly income of $4000 to make a payment on the HELOC, bringing your HELOC balance down to $8000.
- In the course of the month, you put all your living expenses on the credit card. Every month,, you draw $3000 on the HELOC to pay off your credit card and make a mortgage payment of $537.
- Your HELOC balance is now about $11000 plus interest which is about $33 for the first month.
This process is called Paycheck-parking, and the princess continues every month. And every month, your HELOC balance reduces by about $1000 minus interest on the HELOC.
After nine months, your HELOC balance will be down to about $4000, then you can make another lump sum payment of $12000 from the HELOC to your mortgage.
Now, you’ll have a mortgage balance of $74,442, a HELOC balance of $15,154, and a total of $89,596. You’ll have paid off your mortgage by 10.40% and HELOC in 9 months.
You can pay off your mortgage and HELOC in 6 years and four months if you continue with the process.
Here is the flipside.
If you simply made an extra payment of $1000 towards your mortgage repayment every month without utilizing the Velocity Banking strategy, it would take you six years and five months to pay it off.
This gives the Velocity Banking strategy advantage of one month and $1458 of interest saved.
Is Velocity Banking a Good Idea?
Some people believe that velocity Banking covers more than just debts, but everyday living expenses through HELOC. They think that home equity serves little purpose, therefore, it needs to work for you wherever and whenever possible.
Even though this makes sense mathematically, not everyone faces circumstances that warrant the potential upside velocity banking could offer.
Also, the actual implementation of the strategy is much easier said than done.
Therefore we’ll walk you through the pros and cons of velocity banking. But before that, let’s look at some assumptions.
The Assumptions of Velocity Banking
Mainstream financial thinking makes broad assumptions of what’s wrong and suitable for everyone to manage their money. And they think it is practical common sense.
But there is a problem.
Conventional thinking achieves typical results, but you must also elevate your thinking if you want to build uncommon wealth.
Here are some underlying assumptions of velocity banking;
- Paying off your mortgage faster is the best financial decision before meeting other financial goals.
- The most critical factor in paying off a mortgage is saving on interest payments.
- Your home equity counts and savings, and HELOC helps you tap into it.
But following these assumptions/logic, velocity banking robs you of your control.
That’s just a summary because we have a volume of content to cover on this foundational topic. We’ll have a more detailed article on assumptions soon. So now, let’s cover the advantages and disadvantages of velocity banking.
Velocity banking pros and cons
We have looked at how velocity banking works. But what are the pros and cons of velocity banking?
Pros to Velocity Banking
- You pay less interest – Velocity banking requires you to free cash flow and significantly shortens your mortgage repayment period. Paying more upfront saves you compound interest on the principal amount.
- Enables you to pay off your debt early -Helps you pay off your debt faster.
- Frees up your equity – Mortgages dont allow you to tap into your equity, but HELOC combined with velocity banking lets you access the money you wouldn’t ordinarily.
- Quick access to cash – emergencies occur, and HELOC makes money available when you need it most.
Cons to Velocity Banking
- HELOC adjustable rates: It may be challenging to find a bank that offers a fixed rate HELOCs. That puts uncertainty on the amount of interest you’ll pay over time.
- Credit Score – HELOC requires a solid credit score. But you can find other lines of credit you can use to help you build your credit from previous shortfalls.
- You need free cash flow – Velocity banking requires you to have extra cash, which you’ll use to pay off parts of the outstanding balance. You need at least $50 of extra money or more for velocity banking to work for you.
- Appraised value vs. Mortgage balance – When applying for a HELOC, the lender will look at your real estate’s appraised value. But in case the housing market is doing poorly, you may owe more than the property value. Some lenders also require that you have been paying your mortgage for sometime before they allow taking a HELOC.
- MLM schemes commonly used – Multi-Level-Marketing (MLM) schemes are prevalent with this type of mortgage repayment strategy. Some MLMs can scam you trying to sell your course and so on.
So, having looked at both the pros and cons of velocity banking, who is it for?
Who Benefits the Most from Velocity Banking?
Even though velocity banking is not the most effective way to pay off a mortgage, it is a tool that can help you pay it off as quickly as possible. It will help you if you have a hard time saving money or nothing saved in the first place.
Velocity banking helps you put your money to work but you’ll end up paying more interest fees when you could avoid.
Velocity banking helps those who have investment properties but use it in a different fashion. They require a higher extra cash flow and are expected to have more expenses with properties they manage.
HELOC provides that opportunity. You can open multiple HELOCs on multiple properties but it causes a financial burden if one piece of the puzzle suddenly stops working.
Velocity banking step by step
We understand that velocity banking is an approach where you use a line of credit as a form of debt tool or weapon to pay off debt fast.
Here are the general steps;
Step 1: Ensure you have a positive cash flow every month
Having a positive cash flow means your monthly income exceeds your monthly expenses. Velocity banking will not work for you if you have a negative cash flow (expenses are more than income)
Step 2: Open a line of credit
A line of credit could either be a credit card, personal line of credit (PLOC) or a home line of credit (HELOC). HELOC is more preferable because of the low interest rates. However, HELOC is secured by your home, which means you could lose your home if something adverse happens.
You can consider a personal line of credit (PLOC). It is unsecured therefore attracts a higher interest rate. But even if you pay a higher interest rate (that is not amortized), it’ll cost you less in interest if you use PLOC than it would to keep paying amortized debt according to the amortized schedule.
Step 3: Pay down debt using the chunking method
Let’s say you have PLOC for $15000 and a mortgage of $200,000.
One strategy would be to take half, two thirds or all the money in the line of credit and pay it towards the mortgage.
Here is an example.
You could take $10000 from your line of credit (PLOC or HELOC) and put it towards your mortgage. Now you owe $190,000 but remember the total debt remains $200,000. You only shifted a portion of the mortgage to a line of credit.
The $10,000 you put towards the debt is called chunking because you take a chunk (the $10,000) from your line of credit to pay it towards the amortized debt.
Step 4: Put all your income in line of credit
Transferring all your income to a line of credit reduces the average daily balance of the line of credit. And you pay it down faster. It also means putting your extra money to good use instead of having it lie around in a checking account.
Also if you don’t use 100% of your line of credit to pay off your mortgage, the reserve can become an emergency fund.
Putting all your income in a line of credit enables you to use the line of credit to pay all your bills for the month – like you would with a checking account.
Step 5: Repeat step 3 & 4 above until you pay off your mortgage.
Once you have paid back the line of credit down to zero, repeat steps 3 & 4 until you pay off your mortgage. Most people who follow velocity banking pay off their 30-year mortgage in a fraction of the time – sometimes in 5 to 7 years.
Velocity banking strategy
1. Using velocity banking to help you pay off your debt
Velocity banking uses a home equity line of credit (HELOC) to pay down or off your debts and save money by the different way HELOC’s charge interest.
2. Using velocity banking to payoff your mortgage
Once you eliminate other debts, you can also use velocity banking to accelerate paying off your mortgage. You apply the same principle as before by using HELOC to make large principal payments to your mortgage. Then use your paycheck to paydown the HELOC balance.
3. Using velocity banking to buy a house and retain equity as buying power
You take velocity banking a step further and use the principle to buy a home with HELOC. In this case, the HELOC is in the first position as no traditional mortgage exists.
However, this is not an easy task. It requires some significant legwork on your end to locate a willing bank to issue such a HELOC for such a purpose.
Once you buy the home with HELOC, you then apply basic Velocity banking principle to pay it off.
However, for this strategy to work, you have to earn more and have a high credit score.
4. Velocity banking and life insurance
You can use the principles of velocity baking if you own cash value in life insurance. Cash-value life insurance is a type of permanent life insurance that includes investment features. Cash value is the portion of your policy that earns interest and may be available to withdraw or borrow against in case of an emergency.
Therefore, you simply use the policy loan in the same way you use a HELOC with velocity banking.
It allows you to use the same simple interest calculation HELOCs use since life insurance policy loans are similar.
The only exception is that life insurance loans use cash value inside the policy as collateral. Therefore you;ll not be able to extract additional value by virtue of having untapped home equity like in the previous strategy.
You could also potentially buy a home with a life insurance loan and apply for HELOC to use in case of an emergency.
Velocity Banking: Don’t Get Scammed
Multi Level Marketing (MLM) schemes are prevalent with velocity banking strategy.
Velocity banking attracts homeowners who want to pay off their mortgages fast without a hustle.
MLM scammers attempt to sell courses or have you finance through a bank where they receive a commission. Beware of such scammers because you can learn about the concept of velocity banking for free.
Everytime someone mentions MLM and finance in the same conversation, then it brings about a conflict of interest and a red flag.
More resources to help you understand velocity banking
You need some more resources to help you understand velocity banking? Here are two popular books to help you expand your knowledge base.
- Velocity Banking: Ultimate Debt Reduction Strategy
- Velocity Banking For Beginners: A Simple Guide To Paying Off Your Debt Faster
- Using a HELOC for medical expenses
It’s a wrap
The velocity baking principles are quite reasonable. But you must absolutely spend some time working through the calculations to determine if it makes sense for you.
Velocity banking is not a silver bullet and it may not absolutely be your best option to pay off your mortgage.
The velocity banking strategy is for the more hardcore DIYers. But those who aren’t willing to actively manage it or feel intimidated then should stay away from it.
Velocity baking is also not for the risk averse, because it comes with a fair share of risks.