DISCLAIMER: I Am NOT a Financial Advisor. Velocity Banking carries risk, please discuss with YOUR Financial Advisor.
Do you have that one friend or family member who is always trying to sell you something? That person in my life called me a few weeks after I closed my home to convince me that I could pay off my mortgage in 5 to 7 years using Velocity banking. I quickly dismissed Velocity Banking as a Scam. There was no way in hell I was trusting my family’s future, to someone who never owned a home, and can barely make ends meet month to month.
Fast Forward a few years, and a personal finance channel on YouTube that I respected. They always provide well researched, high value information and do not sell anything. This channel was talking with someone about Velocity Banking. Well, I stopped to listen and crunch some numbers to determine Velocity Banking could be a tool to pay off your home faster.
What I discovered is that under the wrong circumstances Velocity Banking is a 100% Scam used to sell products. Under the right circumstances, Velocity Banking can be a tool to pay off debt leveraging your dollar to go further.
To determine fact from fiction when it comes to velocity baking. I evaluated the case study that is frequently used to promote Velocity Banking, against more traditional approaches to accelerating paying off a mortgage.
What is Velocity Banking
Velocity Banking primarily leverages revolving debt to pay off amortized debt or high-interest debt more quickly. The revolving lines of credit can include Personal Lines of Credit or Home Equity Lines of Credit. Amortized debt includes mortgages & car loans. The effectiveness of Velocity Banking can be improved if the revolving debt has a lower interest rate than the amortized debt or high-interest debt.
The Velocity Banking Scam
There are YouTube channels promoting velocity banking with the promise of being debt free within 5 to 7 years. All of these videos claim banks are ripping you off because mortgages are all front-loaded with interest .
Red Flag Number 1 : It seems like all of these people use a ridiculously high 30-year mortgage rate of 6%. According to Freddie Mac Mortgage Rates have not been that high since 2009. By using such a high unrealistic interest rate, these gurus are inflating the benefits of Velocity Banking.
These YouTube Gurus also operate under the assumption that a family taking home $5000 net income has $1400 in extra cash flow sitting in a savings account.
This was Red Flag Number 2 for me. It is HIGHLY unlikely that someone with a monthly income of $5000 after taxes has an extra $1400 in Cash Flow and is in deep debt. Even if that is the case why use home equity instead of pay of the debt directly? (There actually MAY be some benefit here, we will discuss further a little later in the post).
Red Flag Number 3 They suggest you stop saving. Like completely stop saving. No putting money in savings accounts, no contributing to retirement accounts. The rationale is that you can leverage a line of credit in case of emergency. Another rationale is the money you would make in a retirement account is less than you could save on the interest you would save on your mortgage by paying it of sooner.
The example assumes you have a mortgage payment of $1,200 , a car payment of $600 , and credit card payments of $600. They assume you have $1200 in costs such as gas, groceries & incidentals. After your debt and lifestyle expenses, there is $1400 of cash flow left. These numbers are realistic for some people, but if you have an extra $1400 why not just put it toward your debt. Why do you need a Velocity Banking System?
The sales pitch and “guarantee” The promise is that you will increase your credit score, pay off debt faster all without having to pay off your debt faster. Most of these people are selling a service that will allow you to pay bills that you can’t typically pay with a credit card and/or some type of software to optimize your cash flow. Red Flag Number 3 These services cost money and can decrease the effectiveness of Velocity Banking. That is the reason the cash flow and intrest used in Velocity Banking examples are so high.
Velocity Banking as A Tool
Here’s the thing, a lower interest Line of Credit could help you pay down debt faster. If you committed to pay $200 toward an existing debt. Your debt would be paid down faster using a line of credit with a lower interest rate.
I computed the monthly payment based on current average interest rates to determine, how much interest would be saved by consolidating debt on a Credit Card vs a Personal Line of Credit. In this example, you could pay off the debt 3 months faster and save $669 in interest by transferring your debt to a lower interest line of credit. With great power comes great responsibility.
|Credit Card Debt||Personal Line of Credit|
|Interest difference||$0||$669.21 less|
|Time to pay off||2 years and 7 months||2 years and 4 months!|
A few potential pitfalls in this example:
1.) By using the Personal Line of Credit (PLOC) to payoff your credit card. You have the opportunity to dig yourself back into debt. Your credit card balance is effectively zero. If you are not disciplined, you could put yourself into deeper debt.
2.) The minimum payment on the PLOC is about $60. If you only pay the minimum on the PLOC, you could end up paying more interest on the PLOC than you would have if you had continued making the $200 minimum payment on the credit card.
Velocity Banking takes discipline, and if you are not careful, you could end up taking on more debt than you started off with originally.
Velocity Banking HELOCS and Mortgages
When you make a mortgage payment, there are two components principal and interest. The bank uses an amortization schedule, so that your payment remains constant, but the amount that goes toward principal and interest changes over time.
If we use an example of a 30 year fixed rate mortgage of $300k and an interest rate of 4%. Using a simple interest calculation you would owe $12k in interest during the first year of the loan. Again to determine this example I computed the amortization schedule for this loan and summarized it in the table below.
If you decide to make extra mortgage payments and have it applied to the principal, your principal is reduced more quickly.
Now let’s talk about how Home Equity Line of Credit (HELOC)s works. You have to apply for a HELOC, so you will need to have good credit. Unlike the mortgage, the interest is computed based on the daily balance. Also since the HELOC is revolving if you borrow $5000 then pay it back, the $5000 is available to borrow again. When you pay money toward your mortgage, it is not available again until you sell the house.
In the Velocity Banking Videos, they pitch the concept of using “chunks” of a HELOC to pay off your mortgage. For example, you borrow $10,000 and you prepay your mortgage with it. Now you have reduced the principal on your mortgage by $10,000. As a result, you are reducing the amount of interest that you owe. You still make the same payments on your mortgage, but now, more is going toward the principal and this accelerates the rate that your house can be paid off.
The next component of Velocity Banking is that you now use your HELOC as a checking account. When you get paid you put your paycheck on the HELOC. This reduces the amount of interest that you owe on the HELOC. Using the original example of $5k monthly income after taxes, you would deposit that to the HELOC you would pay your bills, and reduce the amount owed on the HELOC by $1400. This is the velocity part of velocity banking.
|HELOC Debt||Deposit||Withdrawal||Average Monthly Balance|
The goal is to periodically pay your HELOC down to zero and then use another chunk of the HELOC to pay off your mortgage. This will accelerate the rate at which you pay down your mortgage. The concept is that now instead of your money sitting in a traditional checking account earning no interest, you use it to reduce/eliminate interest accruing on the HELOC.
This is a very simplified example, assuming you write the check for your bills the day before your next monthly check comes in. This example also does not account for interest due on the HELOC.
Before You Attempt Velocity Banking
Let’s be crystal clear, if you have more expenses than you have income Velocity Banking will not solve your problems. This is known as negative cash flow. To solve that problem, you need to increase your income or decrease your expenses. Velocity Banking is not a silver bullet to fix cash flow problems.
Velocity Banking takes Discipline, again I am not a financial advisor, but I would only consider Velocity Banking if you meet the following criteria:
- You have a Financial Advisor and/or a well thought out plan
- You have positive monthly cashflow
- You Have access to a HELOC or PLOC with a lower interest rate than your debt.