BRADEN SMITH is a Finance undergraduate with a major interest on banking and personal finance. He enjoys spending his time towards school and his blog.
If you’re looking to pay off your mortgage fast, velocity banking is one of many mortgage repayment strategies, but does it really work? We’ll explore what velocity banking is, the pros and cons, and most importantly, who benefits the most from this strategy.
Velocity Banking Explained
Mortgages can take a long time to pay off by making the minimum monthly payments. Velocity banking is the concept of opening a Home Equity Line of Credit (HELOC) and making it your primary checking account where you will deposit your monthly income and pay expenses. When you open the HELOC, you will instantly make a lump-sum payment to your mortgage considering the HELOC’s limit. Now, for a few months, you will receive income and pay expenses within the HELOC (as your checking account), paying off your outstanding balance. Once the balance has been paid off, we can repeat the process of making the lump-sum payments until we no longer have a mortgage.
The idea is that if you have extra money every month, it goes straight to paying off the HELOC, allowing for the frequency of lump-sum payments. There are many variables that go into this strategy, such as the interest rate for your HELOC, early repayment terms on your mortgage, and your current cash flow (income – expenses).
One of the conveniences of using the velocity banking strategy and dealing with a HELOC is that you have the opportunity to use funds to spend where you need it, not just on the mortgage payments. This is not recommended, but sometimes emergencies are unexpected.
Simple Velocity Banking Example
We currently have a mortgage for $100,000 with an APR of 5%. Our real estate has an appraised value of $125,000 in which we currently have $25,000 of equity. We currently have a monthly income of $4,000 and expenses of $3,000 (includes mortgage payment of $567), allowing for a free cash flow of $1,000.
Now we will treat this HELOC as our primary checking account, as the financial institution will issue us a debit card and checkbook. It’s also time to setup direct deposit with our employer into our new HELOC to begin the mortgage repayment process.
Most financial institutions will offer HELOCs with a maximum Loan-to-Value (LTV) ratio of 90%. In relation to our scenario, the bank would offer a HELOC with up to $112,500 based on the appraised value of the real estate. $112,500 (appraised value) – $100,000 (currently owe) = $12,500 approved HELOC. We’ll also give our HELOC a 7% APR on our outstanding balances.
Again, remember that we’ve got $4,000 coming in (income), and $3,000 going out (expenses). Allowing for a free cash flow, or extra money sitting in our account, totaling $1,000.
Now, once the initial velocity banking concept has been setup, we can make a lump-sum payment in the form of a check or transfer to our primary mortgage in the amount of $6,000. We will also indicate this is a principal only payment for the loan.
Once that has processed, our mortgage is now $94,000 and our HELOC balance is $6,000. We will make our monthly payments to our mortgage of $567 (included in expenses), incur some interest expenses on both the HELOC and mortgage, and wait 6 months until our HELOC is paid off.
THEN we will make another lump-sum mortgage payment for $6,000. By this time, we’ve accrued some interest, but also paid off a portion of our mortgage in record time. Notice how the mortgage payment will go down, and the HELOC payment will reset to $6,000 every time we make the lump-sum mortgage payment. Here is what our new liability sheet looks like:
|TOTAL||$92,907 (+$7,093) 7.09% paid off|
|TOTAL||$92,907 (+$7,093) 7.09% paid off|
|TOTAL||$61,836 (+$38,164) 38.16% paid off|
Continue this process for another two and a half years, paying our monthly mortgage payment, along with the HELOC lump-sum payments, we will end up with a much lower balance than if we were to make the minimum monthly payments on our mortgage. At year three, our liability sheet looks like this.
|TOTAL||$61,836 (+$38,164) 38.16% paid off|
3 Years and 2 months later, we would no longer need to use a HELOC, and 3 months after that, our entire mortgage would be completely paid off.
It only took a total of 77 Months, or 6 years and 5 Months to pay off our mortgage, and we only paid $17,468.37 in interest. That’s the superpower of velocity banking, but is it the best mortgage repayment strategy for you?
The greatest part about using the velocity banking strategy is that a HELOC allows for convenience where you have access to equity when we need it. We all know that unexpected situations occur, for which we could simply use some of the HELOC to pay for it.
Advantages and Disadvantages of Velocity Banking
While velocity banking seems like a great way to pay off a mortgage, it comes with a set of rules you need to follow and different stipulations that must be adhered to. Undoubtedly, it is a useful method for paying off a mortgage.
Advantages of Velocity Banking
Pay off your mortgage early – Velocity banking is one of many mortgage repayment strategies that work in your favor to pay off your mortgage. Instead of making minimum monthly mortgage payments, utilizing velocity banking strategies can significantly improve the time it takes to completely pay off a mortgage.
Free up equity – While mortgages don’t allow you to tap into your equity, a HELOC combined with the velocity banking strategy lets you use money that you wouldn’t normally be able to access while also streamlining the mortgage payment process.
Pay less in interest – Because the velocity banking strategy requires free cash flow to be utilized, the length of the mortgage is significantly shortened, allowing for less compound interest on the principal amount owed.
Quick access to cash – It’s hard to expect the unexpected, so utilizing a HELOC can allow people to use money they don’t have readily available. Your car needs some unexpected repairs? No worries because your HELOC can save you.
Disadvantages of Velocity Banking
HELOC adjustable rates – Some financial institutions may not offer fixed rate HELOCs which puts a but of uncertainty on the amount of interest you will be charged in the future of the product.
Requires free cash flow – Velocity banking is a strategy that requires extra monies be used to pay off the outstanding balance of a mortgage. If you lack the extra income or have bad spending habits, velocity banking may not be for you.
Appraised value vs. Mortgage balance – When applying for a HELOC, the financial institution will look at the appraised value of the real estate. Sometimes if the housing market is not doing well, you may owe more than what the property value is, which is a delimiting factor for getting a HELOC. An LTV also requires that you have been paying on your mortgage for some time before the banks will let you take out a Line of Credit.
Commonly used in MLM schemes – An analysis on google and throughout the web indicates that Multi-Level-Marketing schemes are prevalent with this type of mortgage repayment strategy. They attract homeowners looking to pay off their mortgage quick, and without a hassle. MLM scams may attempt to sell courses, or have you finance through a bank where they receive a commission. Beware of this scheme, because learning about the concept of velocity banking is free. When MLM and finance are referred to in the same sentence, you can bet there’s a conflict of interest.
Who Benefits the Most from Velocity Banking?
Velocity banking is not the most effective mortgage repayment strategy as people will pay more in interest payments compared to those who can handle unexpected financial situations and devote their free cash flows directly to their mortgage. Velocity banking can be thought of as a tool to help people to pay off their mortgage as quick as possible, if they have a hard time saving money or have nothing saved in the first place. If you have a lot of money in savings, you could still utilize velocity banking to put your money to work, but you will end up paying interest fees when you could avoid them.
Those who partake in investment properties often use velocity banking, but in a different fashion to which they require a higher free cash flow and are expected to have more expenses with the amount of properties they manage. A HELOC provides that opportunity, but when multiple HELOCs are opened on multiple properties, it can cause a financial burden if one piece of the puzzle suddenly stops working.
Velocity banking is not the fastest strategy for paying off a mortgage. Making extra payments equal to your free cash flow on your mortgage is actually the best strategy when it comes to quick repayment and less interest paid. Just when making extra repayments, you’re not able to see that equity until you’ve sold the real estate or applied for a Line of Credit.