Velocity banking is a banking process used to pay off your mortgage early. If you are a homeowner or plan to become one soon, you have probably searched the term “velocity banking strategy” online.
Usually, a mortgage lasts up to 30 years. With velocity banking, it is possible to pay off your entire mortgage in approximately five to twelve years.
Is velocity banking legitimate? Does velocity banking work?
Some believe that it is real and that it works, whereas others think it is a scam.
The truth is that you can apply a velocity banking strategy and pay off your mortgage early. However, the velocity banking process is complicated, so many give up on it or simply don’t try it out.
Let’s dig into this complete guide to velocity banking that will help you learn how to use the home equity line of credit (HELOC) for debt reduction and total mortgage payment!
What is Velocity Banking?
Velocity Banking — also known as the “HELOC Strategy” — is a personal finance approach and a type of banking that uses a home equity line of credit (HELOC) to leverage disposable income to pay down your primary mortgage while saving the amortized interest.
The concept is based on utilizing a line of credit to help use cash flow and extra money to cover expenses and go toward paying off the mortgage.
What is a Home Equity Line of Credit (HELOC)?
HELOC lets you borrow money against your home’s value to pay off your mortgage.
You can make withdrawals from a home equity line of credit and then either repay the entire balance or a portion of it each month. HELOC is used for velocity banking to repay the mortgage faster and capture the interest.
How does Velocity Banking Strategy Work?
HELOC is used as a primary expense account instead of a checking account. This eliminates the need for a savings account since all free cash flow will go toward the mortgage via the HELOC. Any bills or significant debt payments will be made into this account, meaning the mortgage won’t be paid directly but through a HELOC or LOC.
HELOC functions in a way that enables you to withdraw (it’s also called chunking) and deposit money into LOC in the same way you would do with a bank account. Once you execute the withdrawal, the balance to repay the loan goes up by the same proportion. If you deposit your entire paycheck into the HELOC balance, you will lower the remaining balance.
When using velocity banking, you live off the line of credit, with the balance increasing every time you withdraw the funds and the balance lowering every time your paycheck gets deposited.
The best way to make the most of this concept is to pay off the debts with the highest interest rates first, effectively reducing the interest-rate payments due. Otherwise, you will pay an unnecessarily high-interest rate and be behind from the start.
The strategy includes variations such as opening a 0% interest credit card and moving balances of debt from other liabilities to the credit card and then paying off the credit card fast, using a home equity line of credit.
Depending on how you use the velocity banking strategy, the calculations say you can fully pay off your home quickly, usually between 5 and 12 years.
However, debt reduction isn’t as simple as it sounds, and different factors determine the final results.
Velocity Banking Example
The best way to understand velocity banking strategy and how HELOC is used is through an example.
Let’s imagine the following scenario:
- Ongoing mortgage: $200,000
- HELOC: $20,000
- Positive monthly cash flow: For the velocity banking strategy to work, your monthly income needs to be higher than your expenses.
Here are four steps in which you can pay off your mortgage:
- Take your HELOC at $20,000
- Use the whole line of credit to pay off a chunk of your mortgage, making a mortgage principal the only payment if you can. In practice, this might not be possible, and there will be some other expenses. Let’s assume you pay $15,000 for your mortgage with $5,000 left in the balance (always leave a small amount to serve as your emergency fund). Your mortgage will be at $185,000 after that, with the payments reduced.
- Redirect your monthly income toward your line of credit at the beginning of each month to save on interest. This is known as paycheck parking. It will take several months to build the HELOC balance back to $15,000, but during that time, you will actively make monthly mortgage payments.
- When you accumulate the money, you direct $15,000 to the mortgage and repeat the process until you pay off your mortgage fully.
With this approach, you can save on mortgage interest and pay off your mortgage quickly. Regular payments drain cash flow, and applying the velocity banking strategy is a much better option for homeowners.
Line of Credit vs. Loan
Here we need to distinguish between a loan and a line of credit. In velocity banking, you will use your credit card as a line of credit, and once you pay it up, you will be able to reuse it again.
With loans, the situation is different. You have to take out a loan from the bank that you have to pay off and cannot reuse. Loans are more similar to mortgages, while a line of credit is just you using your credit card for a mortgage payment and as your savings account.
Also, a policy loan is slightly different from a bank loan in the sense that you don’t have a deadline to pay it off. If you choose not to pay it off, an insurance company will take the money from the cash value that you use as collateral.
Benefits of Velocity banking
There are a couple of reasons that make velocity banking attractive to people interested in real estate and real estate investing.
Quick Debt Reduction
With velocity banking combined with a “paycheck-parking” strategy, you can reduce your debt and pay off your mortgage within 5-12 years. This applies to shortening even those 30-year-long mortgages, which is 60-80% quicker than expected.
Quick debt reduction is just one financial benefit, while paying off your mortgage early is why people want to apply the velocity banking strategy.
Monthly Cash Flow and Cash Value Increase
Cash flow — by its definition — is the total amount of money being transferred into and out of a business, mainly affecting liquidity.
With velocity banking, you ensure you track your debt obligations in a meaningful way, thus freeing up the cash you can save or spend elsewhere. If you are responsible with velocity banking, you will not accumulate more debt, and you will maintain a positive cash flow. Not only that, but you can improve your financial situation. The better the cash flow you have, the faster velocity banking can work for you.
Less Interest Payment
Paying interest is something you cannot avoid. If you use your HELOC balance to pay off your mortgage debt, you are trading out your mortgage debt for HELOC debt. This is a good thing since HELOC uses a simple interest calculation, so you will pay less interest than initially planned.
Stress Level Decrease
They say that besides health worries, people worry about their finances the most. Velocity banking is one of the financial strategies that give you more extensive control of your finances, thus leaving you calmer knowing monthly payments reduce your debt, and you are obliged to pay less interest.
Building Financial Freedom
Financial freedom and independence are usually linked to the infinite banking concept. However, it can also be connected to velocity banking too.
Using this strategy can help you erase the high-interest debt and focus on building your wealth sooner while still covering your monthly living expenses and your minimum payments on your mortgage, in addition to the large chunks of money you direct towards the mortgage.
Downsides to Velocity Banking
There are always two sides to every coin – velocity banking is no exception. No matter the benefits of the velocity banking strategy, there are also some sacrifices to be made and downsides you have to be aware of.
Remember that velocity banking is complex to apply, and if you do it the wrong way, you can end up in a worse situation.
Poor Credit Score
A good credit score is a necessity when it comes to opening a LOC. However, whenever you withdraw money from a LOC, your credit score takes a hit.
No withdrawal can go unnoticed, and that’s something you should keep in mind if you want to use other financial services in the future.
Not having complete control over the cash flow
Even though velocity banking is a step towards financial independence, you should know that you won’t have complete control over your cash flow.
There are calculations to be made and the entire system to be followed and respected: depositing paycheck into HELOC, making all the extra payments using a credit card, chunking money into LOC to pay off the amount of interest, etc.
This all requires a positive cash flow to bring you good results.
Requires High Self-Discipline
This might seem easy, but there are countless examples of people who misused their HELOC balance and ended up losing money. You should never withdraw funds from your LOC for regular payments and expenses.
There are rules to be followed – after the first month, they become crystal clear, and the only thing left is your discipline.
Interest Rates Can Change
Although you are doing some things to recapture interest, you cannot affect the interest rate percentage, which may rise. For example, if the housing market drops, your interest rates will change, and there’s nothing you can do about it.
Wrong Assumptions About Velocity Banking Concept
The Velocity Banking strategy sounds very appealing to most. Reducing our lender’s interest rates after applying “paycheck-parking” for the first time shows benefits at first glance.
However, you should know some common myths and assumptions before choosing velocity banking as a strategy.
Here are the most important ones:
Paying Off Your Mortgage Early Only Brings Benefits
We’ve been taught that paying off our mortgages should be our number one priority, meaning that we should use all the possible funds we have and apply strategies to help us get there. This is a fact, but there is a specific price that comes with it.
Often, our homes are our most effective liabilities, and it isn’t by default terrible to have a mortgage on them.
On the contrary, in some cases, it can be more beneficial to continue with the monthly payment while using some free cash flow to build cash value in the whole life insurance or grow savings in any other way.
Not using all available funds only to pay off the mortgage as soon as possible and reducing the mortgage balance slowly can open many doors for you.
Saving On Interest Payments Can Help You Most in Paying Off Your Mortgage
Velocity Banking is built on the assumption that you should save interest to benefit from paying off your mortgage early. Even though interest payments can be an enormous burden, they are often not the most crucial factor in paying off the mortgage.
If you zoom out and consider what’s best for you in the long run, you’ll be able to see that by using all of your free cash to pay off liabilities, you can also end up losing opportunity costs. There are no rules for this, so you should estimate your situation before assuming that saving on interest payments is the most important thing.
If You Have a Liability, You Are in Debt
We see our liabilities as our debts. However, this is not a simple equation that can be easily applied here. The actual definition of debt is “negative equity,” which means you shouldn’t assume your liability is a negative thing in the first place.
In other words, you are in debt only when your liabilities exceed your assets, which means that you shouldn’t, by default, try to become “liability-free” under all circumstances. Instead, there should be a proper evaluation of each liability before determining whether you should keep it or pay it off, as well as the ideal time it should be paid off.
Just because you have a liability doesn’t mean you’re in debt.
You Should Pay Off Debt Before
After you assess all of your liabilities, there should be a paying-off strategy in place. This means you shouldn’t prioritize multiple debt payments above everything else, as there might be higher debts to pay off, leaving you with money and opportunity losses.
You should prioritize paying off the liabilities that free up the most cash flow and keep the most efficient liabilities. To make the prioritization the right way, you should first do a cash flow analysis.
On the other hand, if your long-term goal is to build time and money freedom, you might want to create as much cash flow as possible while keeping healthy savings and paying off the debts gradually.
Is Velocity Banking For Me?
The velocity banking method works in a way, so you don’t have to worry about the monthly mortgage payment as you are paying in chunks. But there are many moving parts, and you will have to change how you think about finances and how you pay your normal living expenses.
And that is not easy.
Although you will reduce the mortgage balance and recapture some of the interest, you need to understand HELOC well and risk your credit score to succeed.
Velocity banking works only if you have positive cash flow and you make it work. Otherwise, it isn’t great for achieving financial independence, although there are some nice components to it.
You should be aware that equity in your house does not equal savings and that it can happen that you can’t access it.
For an asset to be considered saving, it must have maximum safety and liquidity. Additionally, it usually has the most competitive growth.
Home equity does not pass any of these three statements:
- It isn’t safe, as the housing market value can drop, lowering your asset’s worth, and amortization is always a factor
- It isn’t liquid, as no one can guarantee you could convert it into cash (especially quickly and straightforwardly)
- It has no rate of return (your house appreciates regardless of how much equity you have).
Therefore, velocity banking is not a good strategy for managing your finances and will not give you total control over them. You should do the proper analysis and research before starting your velocity banking journey.
Or, you can consider becoming your own banker and using the advantages of having a life insurance policy to build financial independence through the infinite banking concept.
Infinite Banking vs. Velocity Banking
It is all about strategically using your whole life insurance policy from a mutual insurance company as a personal endless banking system.
In other words, you take ownership of your lifestyle, as you no longer have to worry about banks, financial trends, or other banking strategies.
One of the many benefits of a whole life insurance policy is that policyholders can borrow money using their policy’s cash value as collateral. Later, you invest that money and pay it back while paying yourself interest.
You are becoming your own banker, but this process doesn’t happen overnight. It takes years to do it, but once you understand the concept and start applying it, you can pay off your initial debt amounts, invest in businesses, real estate, and stocks, and get more money back.
Thanks to the life insurance policies, you can replicate this process more than once and be your own banker for as long as you want. The longer you stay, the better.
Infinite Banking involves:
- Overfunding (with after-tax funds) a high cash value whole life insurance policy from a life insurance company
- Accumulation of Cash Value(tax-free) throughout the years you are a policyholder of your Whole Life insurance policy
- Tax-Free Loans taken out against your whole life insurance policy’s cash value to use for your financial expenses.
Key Differences Between Infinite Banking and Velocity Banking
In the image below, you can see key differences between Infinite Banking and Velocity Banking:
|Where does your extra cash go?
|Into home equity via HELOC
|Into-cash value in a custom made whole life insurance policy
|Primary reason to use this strategy?
|To pay off debt faster and save interest
|To obtain a death benefit
|Secondary reason to use this strategy?
|To build up investable capital
|To build a side fund of accessible cash
|Where is the balance of my cash?
|In home equity
|In insurance’s cash value
|Is it liquid?
|I can use it during the HELOC’s draw period, if limits are not lowered and the line isn’t frozen
|Contractual guarantees to access cash value with withdrawals and policy loans
|Does it earn a return?
|No, equity and HELOC never earn interest
|Yes, the cash value grows with guaranteed interest and non-guaranteed but highly anticipated dividends
|What is the growth rate?
|After tax, uninterrupted interest + dividends = 3-5% internal rate of return, whether or not you borrow against your cash and have it working in two places at the same time
|Is this a savings strategy?
|No, because value isn’t guaranteed, access isn’t guaranteed, and equity doesn’t have a return
|Yes, because cash value is guaranteed, access is guaranteed, and cash value has a guaranteed growth rate
|Is it risky?
|Yes, because equity lacks safety, liquidity and growth and you have no control
|No, because cash is safe, liquid and growing and you have control
The main difference lies in the places used to store cash. In Velocity Banking, the money is stored in the home equity. In Infinite Banking, the money is stored in the cash value of the life insurance policy. The conclusion is that you can gain much more security and control over your finances by using Infinite Banking than by using Velocity Banking.
We talk more about that here, and if you are interested in learning more about velocity banking, check out this video: