Velocity is defined as the speed of something in a given direction. When applied to debt payoff, increasing the speed of paying down your mortgage can save you thousands of dollars over time.
In recent years, an accelerated mortgage pay-off strategy called velocity banking has gained popularity. Borrowers are given the hope of paying off their 30-year mortgage in as little as 5-7 years if they use this personal finance approach to debt payoff.
Sound too good to be true? Actually, this is a very legitimate method to pay off any large debt you may have.
In this post I’ll explain in simple terms how velocity banking works and how to implement this strategy. I’ll also lay out the reasons you should take caution before using the velocity banking method.
What is velocity banking?
Velocity banking is a debt payoff method used to accelerate paying down a mortgage or other debts. This strategy typically utilizes a Home Equity Line of Credit (HELOC) to maximize net income and pay down your mortgage debt while minimizing interest costs.
Basically, the HELOC replaces your primary checking account, and you use the line of credit to pay off a large “chunk” of your mortgage principal, and all of your monthly bills and debts. As you receive your income throughout the month, you deposit it into the HELOC to pay down the balance.
A debt vehicle such as a HELOC is an optimal tool to help lower interest costs due to its historically low rates. However, this strategy essentially uses debt to pay off debt, which can be a very risky move.
So, why do some promote this as a magic bullet to paying off an entire mortgage faster? Let me go over how velocity banking actually works and why.
How velocity banking works
Before I explain how velocity banking works, let’s review the traditional method for paying off debt.
- Your paycheck is deposited into your checking account.
- You make debt payments with your checking account balance.
- Your debt payments are distributed between the principal balance and the interest.
This standard model for paying down a new mortgage will initially use the majority of your payments to pay off interest.
For example, with a fixed-rate 30-year mortgage, 70-80% of your monthly payment in the first few years will go to interest! This means for the first 5-10 years of payments, you are actually paying very little on the principal loan.
As more principal is repaid, the less interest you pay over time. This causes the principal allocation of your payment to increase, and the interest portion to go down. After you’ve paid a little over half your payments (over 15 years), you will hit the “tipping point”, where your payment goes more toward principal and less toward interest.
A common strategy to pay less interest using this traditional debt payoff method is by “prepaying” your mortgage. This simply means you pay more than your minimum monthly mortgage payment, and have the excess amount go to principal. When you do this, you accelerate the principal payoff, which also decreases the interest at a faster rate.
Now, let’s go over the velocity banking strategy.
- You open a HELOC account.
- You draw down a large chunk of your credit line and apply a lump sum payment to your mortgage.
- You use a credit card to cover all bills and expenses throughout the month.
- As you receive income, you deposit this money back into your HELOC. (It is very important that your total income is greater than your total expenses, so you have a positive cash flow every month.)
- You use the HELOC to pay off your credit card, but leave the cash surplus to pay down the HELOC.
- You repeat steps 3-4 until the HELOC balance is zero. This will take several months, depending on the amount of cash surplus you can apply every month.
- Once the HELOC balance is down to zero, make another lump sum payment to your mortgage and start the cycle over again.
- Repeat this process until your mortgage is paid off.
The big difference between these two methods is the rate at which interest costs decrease.
The velocity banking approach allows you to make periodic lump sum payments on a mortgage, which brings down the principal and lowers interest faster.
Also, with a HELOC you only pay interest on the remaining balance, so interest is calculated on a daily basis. This gives you more control of how much interest you pay as opposed to a mortgage, which charges interest for the length of the loan and calculates interest monthly.
What you need to implement velocity banking
Before you try the velocity banking strategy, there are a number of important factors that must be set in place first. These include:
- A good credit score (go for 680 or better)
- Significant equity in your home
- A considerable positive monthly cash flow (which means you live well below your means)
- Qualifying for a HELOC with an interest rate less than your mortgage rate
- A firm commitment to paying off your debt
Once you establish these requirements, you’re in a good position to use the velocity banking strategy.
A velocity banking step-by-step example
To help solidify your understanding of velocity banking, let’s go through a step-by-step example.
We will assume the following:
- You have a total monthly net income of $8,000.
- Your monthly outgoing expenses (including a $1,500 mortgage payment) equal $7,000, leaving you with a $1,000 positive cash flow.
- You have $50,000 in home equity.
- You have a mortgage balance of $150,000 at 6%.
- You take out a HELOC for $25,000 at 5%.
Step 1: You draw down $23,000 from the HELOC, leaving a $2,000 reserve for unexpected expenses that may pop up.
- This results in a $23,000 HELOC balance
Step 2: You apply the $23,000 to your mortgage (a principal only payment if possible!)
- $150,000 starting balance – $23,000 lump sum payment = $127,000 remaining balance
Step 3: You use a credit card to pay all of your monthly expenses ($7,000) for the month.
Step 4: As you receive them, you apply all of your paychecks to the HELOC (this is called “paycheck parking”). This brings down the HELOC balance.
- $23,000 HELOC balance – $8,000 income applied = $15,000 HELOC balance
- Applying your paychecks to the HELOC as soon as they are received will lower the HELOC balance faster, resulting in lower interest.
Step 5: You pay your credit card bill (which should be close to $7,000) with the HELOC. You leave your monthly surplus of $1,000 to pay down the HELOC balance.
- $15,000 HELOC balance + $7,000 credit card bill = $22,000 HELOC balance
Step 6: Repeat steps 3 to 5 every month, slowly paying off the HELOC balance with your $1,000 monthly positive cash flow until it’s completely paid off. This will take you a total of 23 months.
Step 7: Once the HELOC balance is zero, you start over again from step 1. You repeat this cycle until your entire mortgage is paid off!
There are many factors that will influence your mortgage payoff timeline. It will depend heavily on the varying rates of your HELOC, if your income and expenses stay consistent or not, and the number of years left on your mortgage.
You could use a velocity banking calculator, but keep in mind that the results you’ll get only represent a snapshot in time. As factors change, those results will look different.
Common assumptions made with velocity banking
Whenever you use debt to pay debt, there are inherent risks you undertake. It’s important to do your homework so you fully understand the assumptions you need to accept if you choose to implement this debt payoff strategy.
Here are 5 beliefs you should adhere to before moving forward with velocity banking.
1. Paying off my mortgage loan early is the best financial decision I can make
The velocity banking debt payoff method assumes that your smartest and most beneficial financial move is paying off your primary mortgage early.
This belief will motivate you to use all available funds to achieve this goal (which means other goals like saving money and building retirement funds go on the back burner).
If paying off your mortgage early is not a priority, you should not use this strategy. Instead, determine what your financial objectives are, and find effective tactics that align with them.
2. Minimizing interest costs is the best strategy to payoff my mortgage
The concept of velocity banking revolves around minimizing interest costs on your debt. Using this method effectively will depend on your motivation to cut interest expenses as much and as fast as you can.
This means paying close attention to the rates your debt is subject to, and using all available funds to pay down balances to which this interest is applied.
3. I will need to align my financial priorities with the velocity banking method
Focusing all of your efforts exclusively on paying down your mortgage will require you to make some sacrifices in other areas. This is what’s commonly referred to as opportunity costs – those opportunities you’re giving up in order to achieve your main goal.
If you highly value annual vacations, maxing out your 401(k), or paying down your student loans, then applying velocity banking to your mortgage may not be the best decision for you. Take the time to identify your money values, and structure your financial goals around them.
4. Being debt-free is more important than saving money
Paying off your mortgage early will save you thousands in interest payments, but it will still take years to accomplish.
Your commitment to being debt-free for an extended period of time will have an adverse effect on your savings account. If you put all of your disposable income towards debt, you might be short on savings when you need it. You will need to decide if the benefit is worth the cost.
5. Using debt to pay debt is an effective strategy
This is a big one. To use the velocity banking strategy, you will need to be comfortable with utilizing debt vehicles (such as a HELOC) to pay off other debt. This will require the discipline to stay on course so your debt balances do not become unmanageable.
For some, this strategy can create a degree of anxiety due its risk factors. If you are seriously concerned about your ability to manage additional debt, you should probably adopt a different approach to paying off your mortgage.
Benefits of velocity banking
There are a few reasons why velocity banking has become such a popular debt-payoff strategy in the past few years.
Here are 4 main benefits of velocity banking:
1. You can decrease your debt faster
As mentioned earlier in the post, most of a mortgage payment is applied to interest for over half the repayment period. Decreasing the principal balance at a faster rate with lump sum payments will reduce the interest costs over time. This helps you to take years off of your mortgage.
2. You pay less in interest
Who likes to pay interest? Paying money to borrow money isn’t an effective way to maximize your income.
Because a HELOC uses simple interest (as opposed to a mortgage’s amortized interest), you have more control of lowering your interest expense each month. Just make sure you can qualify for a HELOC rate that is lower than your mortgage rate.
3. Velocity banking requires intention and focus
It’s critical that you consistently track your debt payoff progress when you apply velocity banking to your mortgage. Otherwise, debt balances could quickly get to an unmanageable level.
In other words, you could say that the risks involved with velocity banking will require a heightened sense of awareness and focus, which are extremely helpful in successfully achieving financial goals.
4. Working towards debt freedom can create greater financial independence
A mortgage payment is typically a person’s primary expense every month. Most people aspire to pay off their mortgage before they retire, so they can have a greater sense of financial independence and security.
Owning your home outright can free up a significant amount of discretionary income that can be used to build your retirement fund.
Disadvantages of velocity banking
At first glance, velocity banking seems like a simple and straightforward method to paying off a mortgage early. However, using debt to pay off debt comes with some significant risks.
Here are 8 disadvantages to using velocity banking.
1. More liability equals more risk
As long as your current circumstances stay the same, it’s easy to see how velocity banking could successfully pay off your mortgage faster.
However, life often likes to throw curveballs – especially at the most inconvenient times. If you find yourself suddenly out of work, or your expenses unexpectedly increase, you might find yourself in a cash crunch that will leave you in some financial trouble.
2. Having access to a large line of credit can be tempting
Velocity banking requires a long-term commitment to one goal: paying down your mortgage *while* you’re paying down the HELOC.
If you don’t think you have the financial discipline to stay focused on your objective, you may find it too tempting to have a large line of credit at your disposal. This can turn into a slippery slope for those who do not have their impulse spending habits under control.
3. You may experience an increase in financial stress
For those who are risk averse, increasing your liabilities may just add unwanted stress. Decide if the disciplined effort it will take to manage your cash flow with this strategy will be feasible.
If just thinking about the various moving parts you must address on a weekly or monthly basis causes your blood pressure to rise, then I don’t recommend using velocity banking. Save your health and maintain an acceptable level of peace by using another way to reach your financial objectives.
4. Your credit score may suffer
Whenever you draw money from a line of credit, your debt to income ratio will go up. This could have an adverse effect on your stellar credit score, leaving you vulnerable to rejections for future credit needs.
5. Your margin of error is reduced
Due to the nature of the velocity banking strategy, you will have little room for deviations from your payoff plan if you want to be successful.
This means you must maintain your current income, keep your expenses at or below their current level, and be precise with your cash flow calculations. The whole purpose is to reduce interest costs and eliminate debt faster, and this will require a strict adherence to the system’s rules in order to achieve this goal.
6. Your savings will suffer
This might be the biggest disadvantage of all. While you’re paying down your mortgage and HELOC, your savings account will likely be neglected. Although you are building more equity in your home, you won’t be building liquid cash reserves that are easily accessible for emergencies.
7. HELOC rates are typically variable
This means your rate could change after a specified period of time, based on current economic conditions. If it happens to rise higher than your fixed mortgage rate, the strategy is no longer effective.
8. HELOCs are secured against your house
If, for some reason, you default on your HELOC, you could risk losing your home.
As you can see, the list of disadvantages is twice as long as the advantages. If you’re considering velocity banking as a personal finance strategy, be sure you weigh the pros and cons so you can make an informed decision.
Alternatives to velocity banking
If you think velocity banking is not the right financial strategy for you, there are additional options for getting your mortgage paid off early.
Here are 5 optional ways you can accelerate your goal of being mortgage-free.
Make bi-weekly payments
With a typical monthly payment plan, you would make 12 payments in one year. However, if you make half of a payment every two weeks, this would equal 26 half payments, or 13 full payments total.
Consistently getting in that one extra payment every year (without much effort) can actually shave off a few years from your mortgage. It’s an easy way to make a bigger dent in your mortgage debt balance.
Make bigger or extra payments when possible
If you can’t maintain extra payments consistently, just make them when you can. You can also make more than the minimum payment. All funds above the minimum payment should be applied to your principal, which reduces any applicable interest.
Refinance your mortgage
This is an easy way to reduce the total cost of your mortgage. I have done this several times over the years, and have saved thousands of dollars. Even a one half percentage point lower can make a significant difference in the long term. You could also refinance to reduce your terms from a 30-year payment term to a 15-year mortgage.
There are several factors to consider before you refinance your home. Simply lowering your payment won’t reduce the total cost, especially if you only have 10 years left on your current mortgage and you refinance for another 30 years. Using a refinance calculator will give you an idea of the terms you’ll need to pay your mortgage off early.
Funnel all excess income and cash to your mortgage
If your monthly budget is tight and you can’t afford to make higher payments, commit to applying all excess cash you receive toward your mortgage.
This extra money could include tax refunds, work bonuses, stimulus checks, monetary gifts, inheritance money, etc.
Always confirm with your mortgage provider that all excess payments are going directly to your principal, and not to interest.
Use the Infinite Banking principal
If you’ve never heard of Infinite banking, it is a legitimate way to borrow extra cash by leveraging the cash value of a whole life insurance policy. This concept is often touted as “becoming your own bank” because you are essentially borrowing from yourself.
Whole life insurance is referred to as a permanent policy, because it is guaranteed for a person’s lifetime (as long as the payments are made on time). Monthly payments are higher than term life insurance, and are partially applied to the cash value portion of the policy.
Although it can take years of payments to build up a significant cash value, you can eventually borrow against this portion to fund large expenses through withdrawals or policy loans.
In order to take advantage of this strategy to accelerate your mortgage payoff, you would need to have a whole life insurance policy in place that you’ve been paying on for several years. (It’s recommended to have a life insurance cash value equal to at least 10% of your regular income.) If this is your situation, contact your insurance provider for all the fine print details.
Why you may want to avoid the velocity banking strategy
The steps to implement the velocity banking process might seem straightforward, but the process can get complicated and unmanageable if your financial circumstances change. There is also greater risk to your financial security when you use debt to pay back debt.
The bottom line, when it comes to paying off a mortgage early, is to make higher payments than the minimum required. There are various ways you can do that, and velocity banking is just one strategy. However, there are less risky methods you could use.
If you don’t currently have a substantial positive cash flow and 6-month emergency fund, you may want to keep it simple and just make higher payments when you can. This approach will still help you reach your goal, but not put you in a risky position.
Also, you may not be in a financial position to carry out velocity banking successfully. You will need a good credit score to qualify for a HELOC, significant equity in your home, and a cash surplus in your budget every month.
Keep in mind that paying off your mortgage early is not necessarily the golden ticket to financial freedom. When you stick to regular payments over 30 years, you have more cash flow to apply toward other debts, college tuition, retirement funds, investments, etc. Decide what your priorities and money values are, and align your financial goals with them.
Using a HELOC to pay down your mortgage is simply acquiring an interest-accruing loan to pay down another interest-accruing loan. This does add another interest-expense component to your overall financial structure, which has the capacity to be a burden instead of a benefit if the strategy is not carried out correctly.
Transferring debt can be an effective way to save money if all of the moving parts are working in your favor. You must determine if you have the capacity and discipline to stick to the process for an extended period of time, and can bear the risks involved without becoming overwhelmed.
Is velocity banking a legit debt payoff strategy?
Velocity banking is a legitimate strategy to pay off debt early and save on interest costs. However, it does have risks that are not present in other debt payoff strategies.
You also must have certain financial components in place (good credit score, positive cash flow, significant home equity) before you can be successful with this method.
Why does velocity banking work?
The velocity banking concept is centered on lowering interest costs. It is a strategy that allows you to accelerate payments to your mortgage principal, thus lowering the interest portion of your loan.
The faster you can lower your principal balance, the more money you will save on interest. This ultimately results in an early mortgage payoff.
Can you use velocity banking with a credit card instead of a HELOC?
You can use the velocity banking strategy with a credit card. However, the credit card interest rate must be lower than the rate on your mortgage.
You can maximize your savings by using a promotional 0% interest credit card. These promotions are for a limited time before they convert to an applied rate, so it’s critical that you limit the use of this strategy to the deadlines of the promotion.
Can you use velocity banking to pay off other debt balances besides a mortgage?
Because credit card balances are typically smaller than a mortgage, and subject to higher interest rates, velocity banking can be a very effective strategy for paying off this type of debt.
If you have significant equity in your home, you could likely pay off those high-interest credit card balances with one HELOC draw.
What are the requirements for velocity banking?
To be successful with velocity banking, you will need at least 15-20% equity in your home, as well as a good credit score to qualify for a HELOC.
Also, you must have a positive cash flow in your monthly budget, which means you consistently live below your income. Having a surplus of at least a few hundred dollars a month is needed to achieve your goal.
What are the risks with velocity banking?
Velocity banking is essentially acquiring interest-accruing debt to pay off a different interest-accruing debt. Although the goal is to minimize interest by leveraging a HELOC’s lower rate, you will still be increasing your liabilities.
More debt will always mean more risk for your financial life, because if your circumstances take a hit then you can get into hot water pretty quickly.
How can I save on interest with a HELOC?
A HELOC calculates simple interest on your daily balance for every billing cycle. You can minimize interest costs for a HELOC by depositing your income at the beginning of the billing cycle, then paying your bills at the end of the billing cycle. This is often referred to as “paycheck parking”, which minimizes the HELOC balance for the majority of the month and interest accumulation.
Is a HELOC interest rate fixed or variable?
A Home Equity Line of Credit (HELOC) is a variable-interest credit product. This means the loan interest rate will fluctuate over the typical 30-year terms, based on the benchmark prime rate.
You can, however, lock in a remaining balance at a fixed rate. This essentially converts the HELOC into a home equity loan.
Is it important to pay off my mortgage early?
Your decision to accelerate your mortgage payments will ultimately depend on your financial goals. There are advantages to both paying off a mortgage, and keeping it for the entire repayment period.
If you have an affordable mortgage, you may want to apply excess cash flow toward other financial goals (like retirement savings.). However, many financial advisors will recommend having your mortgage paid off by the time you retire.
What fees are associated with a HELOC?
HELOC fees will depend on lender policies. They can range from annual maintenance fees to withdrawal fees. You will also have to pay closing costs, and you may be charged for early closure of the account. Ask your lender to put in writing all fees and charges associated with their HELOC product.
What should I do before I start velocity banking?
There are a few steps you should take before applying the velocity banking strategy to your debt:
– Be sure your mortgage provider is cooperative with your efforts to pay down your mortgage principal. Some banks do not automatically apply additional payments to the principal balance, or can charge fees for “chunking” payments.
– Check your credit score to make sure you can qualify for a line of credit.
– Do your homework to find the lowest HELOC rate you can qualify for, as this will maximize your savings.
– Take a detailed assessment of your income and monthly living expenses to make sure you have the necessary positive cash flow to be successful.
– Try to secure a low-interest credit card for your normal living expenses.
What would cause a velocity banking strategy to fail?
There are a few important factors that must be maintained in order for a velocity banking strategy to succeed. If the HELOC interest rate goes up, the housing market declines, or your positive cash flow decreases, you may get into some serious trouble.
In conclusion: Velocity banking is not the best strategy for everybody
If you want to pay off your mortgage early, velocity banking may be a viable option for you. Although it does have some risks, you can legitimately accelerate your mortgage payoff if you have the focus and discipline to follow the process consistently and thoroughly.
Some people who are very motivated and disciplined can make it work and be successful. However, most people should probably stick to the simple method of just making additional mortgage payments. Both are practical and effective, but the second option has less risk.
Be sure to do some thorough research of all aspects of velocity banking before you attempt to take on any more debt than you already have. You alone are the only one who can decide which strategy would work best with your money mindset and financial habits.
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