Velocity Banking: Is it Right for You?

Everywhere you look there is some new way to make money or use money that is supposed to help you build wealth fast.  One of those things that have been recently gaining in popularity among homeowners is velocity banking.  But what exactly is velocity banking and is it right for your long term goals?

At its core, velocity banking is leveraging one form of debt to pay back higher costing debt by taking advantage of varying interest rates and simple interest calculations.  

But where debt is concerned, there is definite risk.  And getting into more debt to pay off another has its downsides.  And for some, it may not be worth it.

So let's take a look at what velocity banking is, how you can start using it, and its pros and cons.  We will also look at some alternatives that you can use if velocity banking is just not for you.

What is Velocity Banking?

Velocity Banking is a debt payoff acceleration method where you would use a revolving line of credit such as a credit card or a Home Equity Line of Credit (HELOC) to pay back debt fast.  Essentially, it is leveraging debt to maximize cash flow and pay back higher costing debt using strategic lump sum payments.

By using these lines of credit to make big lump sum payments, you would, theoretically, pay off debt much faster and save on the total amount of interest paid.  Proponents of velocity banking say you can even pay off your mortgage in 6 years!

It is especially useful to use velocity banking to quickly pay off debt that is amortized.  This is because with that kind of debt most of the interest will be paid up front.  So by sending big lump sum payments you can reduce the debt faster by reducing the principle.  In turn, this will reduce the amount of interest you pay in the long run.

Though most people use velocity banking to pay off their mortgage, it can also be used to pay off any debt like your student loans or credit card bills.  In fact, it might be better use velocity banking with credit card debt especially because of their high interest rates.

How Velocity Banking Works

Using Your Credit

There are many different ways that you could do velocity banking.  All you would need is a revolving line of credit.  So this could be a credit card, a personal line of credit, or a HELOC.  

I don't recommend using a credit card as their interest rates are extremely high.  Unless you manage to snag a 0% rate for the years it'll take you to pay off your mortgage or student loans.  Then maybe that could work.

Personal lines of credits tend to have high interest rates as well.  HELOC's tend to have the best rates so sticking with them to do your velocity banking may be the best bet you have to making it work in your favor. 

Of course, to actually be able to get a HELOC you're going to need to own a house that has some equity.  And it would be best, if you have excellent credit.

The Steps

To start using velocity banking to your advantage, first open a HELOC with your bank.  Then take a lump sum amount, say $10k, out of that HELOC and use it to pay for your mortgage.

When you receive your monthly income,  use all of it to pay down your HELOC total.  And for your monthly expenses, use your credit card.  Then at the end of the month pay the card off in full using your HELOC.  

By transferring your debt to your HELOC and strategically paying it down, you are able to save yourself money on interest by using the fact that the interest you pay is based on the daily average.

The trick is getting the timing right.  You want to maximize the number of days that the HELOC has a low balance so that your interest will stay low as well.  One way to do this is by paying it down early with your monthly check.  And waiting till much later to take more money out for your expenses.

Method 2 

Another way velocity banking can be done as it relates to your home mortgage, is by taking out a HELOC big enough to replace the mortgage.  It might be difficult to find a bank that will do this but it can be done.  This would give you greater access to your home's equity.

Velocity Banking in Action

Say you have a house with a 30 year mortgage of $200,000 at an interest rate of 3%.  The home is valued at $250,000 so you are able to get a HELOC of $50,000 with the bank at a 3% interest rate as well.

Now, you take $15,000 from your HELOC and put it towards your mortgage.  Then when you receive your check of $5,000, you put it all towards paying down your home line of credit.  Your HELOC now stands at $10k and your mortgage at  $185k.

For the rest of the month, you use your credit card to take care of your expenses ($3,000).  Then at the end of the month, you pull out an extra $3k from your HELOC to pay off your credit card.  So now your HELOC balance is $13k.

By using your credit card for expenses during the month, you can keep the average daily balance in your HELOC low.  And so your interest will be low as well.

For the next few months, you take your check and pay down your HELOC.  The next month your HELOC will be down to $11k after you pay your expenses (which includes the mortgage).  The month after that it would be down to $9k.  

Eventually, when your HELOC is low enough, you'd start the process all over again, taking out a big lump sum and paying your mortgage. 

All in all, you will have paid off your debt in a 5 years and 4 month and you would've saved yourself $87,080 in interest.  Of course, with the interest from your line of credit added in, you would save about $86,000 in total interest.

Concerns With Velocity Banking

While velocity banking may sound like the perfect plan to some there are a few things you should be aware of before you dive right in and get started.

First, for velocity banking to work, you need to be a good saver.  Second, you should be living below your means.  And not just a wee bit below your means but considerably.  

As everyone's situation is different, you would have to crunch the numbers yourself.  But I would say. if you are not saving at least 15% of your income maybe velocity banking isn't for you.

Also, there are a few more things about your HELOC that could make velocity banking not worth it.  Here's a few of them:

• Your HELOC's interest rate is too high
• HELOC account is too small 

In addition, your bank may change the rate on your HELOC so be prepared to recalculate regularly to see if velocity banking still makes financial sense.

The Pros of Velocity Banking

One of the major benefits of using velocity banking is that in the long run you could pay less in interest.  By sending in lump sums of cash to pay off your mortgage periodically, you reduce the principle quickly.  And it is this, that can save you thousands of dollars in interest.

Velocity banking also helps you pay back debt much faster.  Many advocates claim you can pay off your 30 year mortgage in just 6 years!

Also, by opening up a line of credit, you will always have access to cash should an emergency arise even after you have finished paying back your debt.

The Cons of Velocity Banking

A pretty obvious downside of velocity banking is you will be getting into more debt to pay off another.  Because of this, velocity banking is pretty risky.  Worse comes to worse you may end up losing your home altogether.  

And for some of you, having to balance these debts could cause you more stress than you can handle.

For instance, if a serious medical emergency arises in your family, you may have to use your income to cover it.  Now, instead of paying off the debt, you'd be getting into more debt.  The exact opposite of what you'd want.

Furthermore, the interest rate on your line of credit fluctuates and could go up. If this happens, the numbers may no longer work and you could be losing money instead of saving it.

Or what if your bank may decide to freeze your account.  What happens then? Well, at that point you would be S.O.L.  Because without your HELOC account, you wouldn't be able to continue with your velocity banking plans.

What's more, with all the fancy footwork and extra lengths you are going through to use velocity banking, in the end, you could end up only saving a couple hundred dollars in interest and shaving just a few years off of your timeline.

Would it be worth it then?

Not to mention the fact that while you are hyper-focused on paying off your mortgage, you haven't been saving for your retirement nor investing for you or your child's future.  

It's a trade-off.  So think about what you'd have to give up to do velocity banking.  And decide whether it's worth it.

Why You May Not Want to Use the Velocity Banking Strategy

Velocity banking isn't for everyone and it may not fit into your future financial plans.  For one thing, it assumes that paying off your mortgage is the most important thing you could do financially.

Even more than investing for your retirement, taking vacation with your family, investing for your child's future, etc.  All of which you would be neglecting in your attempt to pay off your mortgage in 6 years.  

For many of us, that might not work with our financial plans.

I know I for one want to retire early.  And to do so I must be investing regularly.  So it's not worth it to me to put off investing for my retirement while I pay off my house.

Mortgages still to this day have some of the lowest interest rates around.  So it may seem silly to try to rush and pay it off when there are better things you could be doing with your money.  

Like, for instance, investing in the stock market which historically has returns of 10% annually.  That means your money would be earning 7% more by investing than paying off your mortgage with an interest rate of 3%.  Which means in the end you'd be much better off investing.

Furthermore, in rushing to pay back your mortgage, you may miss out on years of tax deductions for the interest you'd pay and other tax saving opportunities.

Alternatives to Velocity Banking

Since the goal here after all is to save you money on interest and save you time, there are other ways to go about it that don't have you shuffling money across various forms of debt.

For starters, you could your tax refund, bonuses, bday gifts, and other monetary windfalls you get during the year and put them all towards your mortgage payments.

And let's not forget good ol' fashioned saving and living below your means.  That will go a long way in boosting your mortgage payoff rate.  

For instance, in the velocity banking example above, you had $2000 of extra income every month.  So you could take that extra income and put it towards your mortgage.

By doing this, you would have saved $83,315 in interest and paid off your mortgage in 6 and a half years.

That's not that too far off from the savings of about $86,000 using the velocity banking method.  And it would only take you a year or so longer to pay it off.

All in All

While velocity banking can save you a couple thousand dollars as well as shave years off of your debt repayment plans, it simply won't work for everyone.  You have to decide for yourself if velocity banking fits into your financial plans.

So you may have a lot of number crunching to do.

But never fear, if velocity banking is not for you there is always the good old fashioned way of paying debt off fast.  And that is, earning more money, saving more, and putting all of that extra savings towards your debt.

Good Luck!