Are you looking for a quicker way to pay off your mortgage?
I’m always trying to find better ways of making my money work for me, and I recently came across the idea of velocity banking.
It’s described as a great way to pay off a 30-year mortgage in 5-7 years. Some people even think it can be 60-80% quicker.
It sounds great, doesn’t it? However, I’m always suspicious of financial fads, so I’ve looked into it further.
Could it work for you?
Here’s my guide to velocity banking for
dummies smart people who want all the facts before jumping in.
Content related to velocity banking:
1. How does velocity banking work?
Velocity banking is also known as the HELOC strategy. This is because many people use a home equity line of credit (HELOC) to increase their cash flow when using this method.
The HELOC is used to pay down your mortgage more quickly than you could by using your paycheque or salary alone. This saves money because you pay less interest to the bank over the life of the credit.
Businesses use a similar mechanism when they issue bonds to raise money for certain purposes, such as paying off debt. In the process, they increase their leverage and optimise their investment returns.
With velocity banking, you effectively do the same thing but at a personal level.
The big practical difference from the business analogy is that once you have your HELOC, you use this as your current, or checking, account instead of your bank account.
In theory, the process gives you some financial freedom because it’s not a service provided by a bank, and you pay off your mortgage more quickly. In practice, you are increasing your debt which has its own set of implications.
But, at its core, what velocity banking is really doing is changing how and when your debts are paid, meaning you can pay them off more quickly. Hence, the name.
Here’s how it’s done in practice:
Velocity banking step by step
- You take out a HELOC or other line of credit.
- Then, redirect all your income to that line of credit. This is known as paycheque parking.
- Pay all expenses from the line of credit (not from your bank account).
- No savings. They don’t earn much interest, so are not working for you – add them to your line of credit.
To pay off a mortgage:
- Take out a HELOC. E.g. £10,000.
- Use the whole line of credit to pay off a chunk of your £250,000 mortgage, making a principle-only payment if you can. Your mortgage is now £240,000, and your payments will be reduced.
- Redirect your income to the line of credit to pay back that £10,000. This takes a few months, during which your monthly mortgage payments will still be taken from your line of credit. Your mortgage will now have reduced. Once the line of credit is paid back, move on to step 4.
- Repeat steps 1-3, taking another £10,000 off your mortgage each time.
Paying off your mortgage in this way is known as chunking.
What’s the difference between a line of credit and a loan?
Lines are revolving.
A credit card is a line of credit. You can use the credit up to a certain limit, and once you pay it back, the line is open to you to reuse it.
In contrast, a loan is a one-way transaction, like a mortgage. You take out the loan, and you have to pay it off. But you cannot reuse the amount you have paid off. It’s a one-time-only use.
If you want to see how fast you may be able to pay off a mortgage, a velocity banking strategy calculator may be useful.
However, it may only be used as an approximate indicator.
Even the most accurate velocity banking calculator will only give you a snapshot of your own situation. This is because they don’t manage the daily ebb and flow of your cash – only you can do that.
2. Why does velocity banking work?
Did you know that money has velocity?!
Effectively, money’s velocity is the speed at which we spend it: the number of times it moves from one entity to another.
In a healthy, growing economy, the velocity of money is high as people borrow and spend. In a recession, the velocity of money is low because people stop spending.
Velocity banking uses the velocity of money concept to increase the amount and value of the transactions you make.
And by chunking your mortgage, or other debts, you reduce your interest payments and pay your liabilities off more quickly.
If you have multiple debt payments, you can increase your velocity as these payments drain cash flow. Once you redirect one, the impact of velocity banking will snowball with each amount you reclaim.
Velocity banking is about focusing on managing your cash flow more effectively by optimising your ability to pay your debts. And since lenders often charge interest on your daily balance, it also makes the most of the interest cancellation effect by reducing that balance.
Pay off high-interest debt rates first to make the most of it
Obviously, you want to get rid of those debts you’re paying the most for. So, by focusing on paying these off first, you’ll reduce the money you owe, meaning you’ll be debt-free sooner.
3. Is velocity banking bad?
Nothing I’ve written about so far makes velocity banking bad or illegal.
Velocity banking is legit. However, it is risky.
For example, you’ll be paying interest in two or more locations, and you’ll need to keep a close eye on this. If you get the cash flow wrong and don’t pay what you owe to where you owe it and on time, it could end up being an expensive mistake.
4. Is there something I should do before velocity banking?
Your mortgage provider may not allow chunking payments or may charge you for the privilege. You need to check this before even considering the velocity banking process.
You will also need to know your current interest rates on your mortgage and other debt, your initial debt amounts, the minimum payments required on each debt agreement and your current amortisation on any amortised dent, such as a mortgage.
In addition, an assessment of your income and expenses is crucial.
The more accurate you can be with this information, the better assessment you will make and the less likely you are to be surprised by charges you hadn’t factored in.
Checking your credit score is also essential – you need a solid one. Remember, you’ll be taking out another line of credit which may affect your score.
And you need a credit card to pay for normal living expenses.
However, maybe the most important thing is to prepare yourself mentally. You’re about to go into hard money conservation mode, focused completely on debt reduction.
5. Pros of velocity banking
a. Variable interest rate risk is good
Many articles I’ve read about velocity banking state that if there is a variable interest rate risk on the line of credit you take out, or on your mortgage or other debt, this is a bad thing.
However, banks and credit institutions are guided by the base rate when setting fixed rates. And they’ll always set a fixed percentage above this that will earn them money when entering into a debt agreement with a customer. They’re businesses, after all.
However, central banks are highly unlikely to ramp up interest rates overnight. because too many people will likely default, causing financial chaos. When central banks do increase interest rates, usually when inflation rises, it happens gradually and over time.
If you’re willing to take the risk that interest rates may move up, you can probably find some good deals on variable-rate lines of credit and/or debt. But, you’ll have to keep tabs on this – don’t let rate moves catch you out in your cash flow calculations.
b. Improves cashflow and reduces amortised interest
By taking out a line of credit, you have more monthly cash available to pay down your interest payments. And by paycheck parking, you ensure your new line of credit is paid back.
c. Smaller interest payments
Provided your choice of HELOC uses simple interest, and it is less than your mortgage, you should have smaller interest payments to pay back each month. Of course, if the interest on your HELOC ends up being greater than that on your mortgage, it defeats the object of the exercise.
d. Getting out of debt feels good.
Getting out of debt can really liberate you and create a new level of peace and happiness in your life. Reduced stress often means better long-term health, which is not to be sniffed at.
e. Financial independence more quickly.
If velocity banking works as planned, you may become financially independent more quickly.
a. Does it really reduce stress?
Personally, I find the whole concept of velocity banking exhausting! Having to watch your cash flow so closely when your children are at school, with the constant requests for small amounts of cash that involves, is highly stressful to my way of thinking!
b. Velocity banking may reduce your credit score
I’m not an expert on credit. But, I have read that your credit score may reduce when you withdraw money from a line of credit. My credit score is ok currently, but reducing it is not something I want to get into.
c. You don’t have complete control over cash flow.
Despite the illusion of control and discipline, your monthly outgoings are already planned for you with no slack in the system. Using velocity banking is like being on a financial treadmill in my mind. I like a bit of slack for the odd emergency, or even for lunch with my girls.
d. Requires accurate calculations
Are you 100% sure you’ve calculated all your outgoings correctly, down to the penny? If not, you may be in for a nasty surprise. This worries me – although I’m fairly good with financial calculations, I like to give myself room for errors. Velocity banking takes this away.
e. Slippery debt slope
You’re taking out more debt to pay off debt. This always bothers me, even if I know the interest payments on the first debt are lower than the interest payments on the line of credit. In absolute terms, it’s still more debt.
f. Doesn’t work with negative cashflow
If you spend more than you make each month, velocity banking definitely isn’t for you because it will only make the problem worse.
g. Heavilly affiliated with multi-level marketing companies
From my research, I get the impression that the concept of velocity banking is linked with MLM companies and subscription services, many of which sell tools on how to track expenses or information on how to do it all. I’m not suggesting any wrongdoing here, but I’d be silly not to ask myself why they’re promoting this concept.
In addition, any extra monthly outgoings to pay for these services make velocity banking less efficient as your cash is going to these products and not paying down your debt.
h. Benefits of velocity banking are overinflated
Sometimes, the benefits of velocity banking can be artificially high. People pushing the concept of velocity banking can use high mortgage rates to calculate interest rates in examples, which can make it look like the benefits are higher than they actually are.
i. Proponents say to stop saving
Proponents of velocity banking say we should stop saving and use credit in an emergency.
This strategy assumes saving money is the most important factor. The problem with this is it leaves you with limited free cash flow.
And I like to have money in my emergency fund for emergencies. I then don’t need to pay for using the credit if and when an emergency arises. Or, if it does, it limits the interest I’ll be paying back afterwards.
j. Interest rates can change
Although I’ve previously said that a central bank in a developed economy full of homeowners is unlikely to ramp interest rates up all at once, it doesn’t mean it won’t happen.
There’s also the issue that the rates on your HELOC could change. Perhaps the housing market drops or the bank decides to freeze your credit. All these scenarios will impact your cash flow and may extend the amount of time it will take for you to pay off your debts.
k. You could lose your house
HELOCs are secured against your house. If, for whatever reason, you default on your HELOC, you put your own home at risk.
7. You can do a velocity banking strategy with a credit card
Although the use of a HELOC is the more common way to execute a velocity banking strategy, you can use the strategy with other lines of credit, such as using 0% credit cards, or by moving funds around and paying off your credit card with HELOC.
The principle of paying your higher-interest debts, faster than you’d otherwise do by using the second line of credit with a lower interest rate, doesn’t change.
8. Assumptions of velocity banking
The concept of velocity banking makes certain assumptions. If you have a difference of opinion on any of these assumptions, velocity banking may not be a great fit for paying off your debts.
a. Paying off your mortgage is the best decision.
Velocity banking assumes that the best decision about the use of your money is to pay off your mortgage, or other big debt, to the exclusion of all else. However, I like to invest my money because I can earn more from my investments than I pay to the bank for my mortgage. So, in my case, it’s better to use my cash to invest than it is to pay down my mortgage.
b. Velocity banking requires a change in your financial priorities.
Focusing exclusively on paying off one large debt results in opportunity costs. These are the opportunities you’ve given up to put all your money into paying off your one large debt.
If you want to save for retirement or buy life insurance, for example, velocity banking may not work for you. It requires a fundamental change in priorities or commitments.
c. It’s good to pay off your mortgage early.
Velocity banking assumes it’s good to pay off your mortgage, or other large debt, early. However, sometimes this may not be the case.
For starters, some mortgage lenders will charge you for paying off a mortgage early because they’ll lose money on your mortgage over time. And like me, with my investing, you may earn more money paying into a pension than you may pay in debt interest. If so, it doesn’t make sense to pay off your mortgage more quickly. Not to mention that until recently, mortgage interest was at an all-time low for many people.
At the end of the day, a mortgage is a fairly efficient debt to have, and the aim of the game is financial freedom, not necessarily debt freedom. I’d rather have an affordable mortgage with money available for other things than focus all my cash on paying off a mortgage sooner to the exclusion of all else. That’s not much fun.
9. What can you do instead?
There are alternatives to velocity banking.
a. Velocity banking vs extra payments
If you’ve got some extra cash, then using it to pay off your mortgage could be a great option. It doesn’t increase your other debts, and it actually reduces your mortgage. However, you do need to check there’s no penalty for doing this with your mortgage provider.
b. Velocity banking vs infinite banking
Infinite banking, or privatised banking, is about becoming your own banker.
The idea is that you take out a policy loan from your insurance company. A whole life insurance policy covers someone for the entirety of their life. So, this means it pays out dividends which increase the cash value of the policy over time.
Once you have the policy, you can borrow against it, so you can take money out of the policy as a loan and use it to pay your mortgage or any other debt. This means you’ve got access to a large amount of cash.
However, you need to qualify for the policy in the first place to make infinite banking a possibility. In addition, it’s recommended that someone puts 10% of their regular income into the policy.
This is a huge commitment! What happens if something happens and you can’t keep up with the payments? It doesn’t bear thinking about.
c. Can refinance instead
Refinancing is another alternative to velocity banking to pay your mortgage more quickly. When you refinance, you get a new mortgage to pay off your existing mortgage.
The idea behind it is to lower your interest payments by lowering your mortgage rate or by negotiating a shorter loan term, meaning you’ll pay less overall.
However, look out for closing costs, such as an origination or credit report fee. These can add unexpected expenses to refinancing, and they may increase your monthly costs.
That said, refinancing is far simpler than velocity banking.
Velocity Banking Isn’t For Me
At the end of the day, paying debt down is the only way to get rid of it.
Velocity banking only speeds up this process. However, it also adds an extra element of risk that I personally don’t like.
The theory is good, but in reality, velocity banking can reduce your ability to react to unintended consequences. And, as a mother, that’s not appealing to me.
However, for some people, it could work, especially if you’re willing to commit and are very disciplined with your money. But you’d need a good reason to go all out on paying your mortgage off more quickly, or there’s not much point.
Have you tried Velocity Banking? How did you get on with it?