Can you save money with velocity banking?
In theory, this strategy allows you to lower your mortgage payments while also paying off faster.
In reality, there are more expenses going on that ipan theory, so this method doesn’t always work. But that doesn’t mean it’s not worth considering.
What Is Velocity Banking?
What’s the best way you know to pay a traditional 30-year mortgage?
Most take the traditional road. Pay your bills every month and wait until the last year to pay them off.
If you think about the interest rates, that’s a terrible idea. You often end up paying thousands of dollars more. All because of this chart:
Lenders charge you an interest rate based on the remaining loan principal. But lending money is risky, which is why most of your money goes to pay interest first.
This keeps your monthly payments high because you’ve barely contributed anything to the principal. At first, it seems there’s little we can do to change that.
At least with velocity banking, you could pay more principal than the interest, saving 1000s. That would be like inverting the chart.
People often use HELOCs (Home Equity Line Of Credit) for this purpose, because interest rates work differently. While your mortgage calculates interest yearly/monthly, HELOCs do it daily.
First, you create the HELOC. If we exclude the monthly mortgage payments, you put the rest of your savings here. We use the HELOC to pay for part of the mortgage, which lowers the interest you pay long-term.
Velocity Banking Example
Let’s keep numbers simple. You get a 30-year mortgage for a $100,000 house, 5% APR.
When opening a HELOC, there’s a maximum loan-to-value of 90%. If you didn’t pay any of the $100K yet, and the house is now worth $125K, you have $25K in equity. If you pay for your mortgage every month, that accumulates as well.
$112,500 (appraised value) – $100,000 (currently owe) = $12,500 approved HELOC.
Now, you make a lump sum payment on your mortgage, indicating it’s a principal-only payment. If you pay $6,000:
- Your mortgage falls to $94,000
- Your HELOC balance goes up to $6,000
- You pay for the interest when making the monthly payments for both your mortgage and HELOC
If you pay $6,000 again, you will find your monthly mortgage payments reduced. You’re still accruing interest but not as much as before. Because HELOCs calculate interest daily, they reset every time you make payments.
If you do the math, you could save around $12,000 in interest. Not only are you paying less, but you pay it off in 6.5 years, not 30.
The Bottom Line
Time costs you money. But as you can see, paying sooner doesn’t need to be more expensive.
HELOCs are useful debt tools if you know how to use them. For example, you can invest your credit line in another house and generate cash flow. That should be enough to cover the monthly payments of both your mortgage and HELOC.
Aside from the monthly profits, you could resell that second property for more, pay back your HELOC, and use the profits to contribute your mortgage.