What is velocity banking?
Velocity banking goes by many names and is a much-debated concept by both financial advisors and their clients. So what is velocity banking? Is the velocity banking strategy a good idea for your clients? And where’s the numerical proof?
Fortunately, the Truth Concepts calculators are primed to tell this story and give you the whole truth about velocity banking as any velocity banking calculator really should–no gimmicks, just numbers.
What is Velocity Banking?
People typically employ a velocity banking strategy to pay down mortgages faster. Unfortunately, using the strategy in this way helps people to assuage their fear of paying “too much” interest…without examining whether interest is truly the issue.
In order to pay down a mortgage faster, people will use a line of credit to make lump sum payments on their mortgage and cover expenses, while diverting all cash flow to paying the credit down. Often, people are encouraged to use a Home Equity Line of Credit (we explain here why this strategy doesn’t work).
What people hope is that paying the house off in chunks will free up their monthly cash flow. In reality, the cash flow is just diverted elsewhere, to paying down the HELOC. On paper this can seem like a magical solution, in practice, it’s not the most practical idea.
Why the Velocity Banking Strategy is Flawed
The main issue with the velocity banking strategy is that it uses debt to pay down debt. This may stem from a misunderstanding of the infinite banking concept, which is best used with whole life insurance.
While the cash value of whole life insurance is useful, especially when leveraged via a policy loan, it cannot do more than what it can do. Think of it this way, a policy loan is still a loan–which means that you are paying interest. If you use an interest-accruing loan to pay for your expenses, you’re adding a cost to your expenses. If you use an interest-accruing loan to pay down another interest-accruing loan, you’re simply transferring your interest cost.
By using an interest-accruing HELOC to pay for expenses while you pay down a mortgage, you’re simply paying interest elsewhere. You may pay the house off faster in theory, however, you’re still left with a HELOC balance and your usual monthly expenses. If the HELOC charges less interest, you may come out ahead slightly. However, the difference will likely be insignificant.
You cannot erase debt with more debt. You can simply transfer debt for the possibility of a better interest rate. And if you don’t get a better rate…
Where policy loans, and by extension, the IBC or velocity baking concept, shines is using the debt to secure a cash-flowing opportunity. Buying a rental property with your cash value results in a single loan, and the cash value can be used to pay down that loan. There is only one debt involved, and it is being used wisely.
Using Cash Value for Opportunities and Emergencies
We feel that it is important to stress that the purpose of whole life insurance is to store cash. This cash becomes more powerful when used for emergencies and opportunities because of compounding interest. This does not mean that using the cash value at every turn is going to be the best use of that account.
First, let’s be clear: not every emergency or opportunity is equal. Emergencies are unlikely to present a cash-flowing opportunity. However, the cash value account provides some liquidity without losing the compounding growth. Alternately, not all opportunities are going to be cash-flowing rental properties and may require a longer strategy.
In every scenario, it’s important to look at the math to determine the best possible course of action for yourself or your client. Just because you have a cash value account does not mean it’s well-suited for every scenario.
For example, if you can get a lower interest rate at the bank, take a loan from the bank. Or if you want to invest in a new business venture, it might be wise to seek capital elsewhere first. New businesses can be unpredictable, and if you exhaust your cash value first, and the first year doesn’t pan out, you have few options leftover. If you seek outside funding at the outset, and your first year is in the red, you have cash value to fall back on.
The point is, just because you have access to a leverageable asset like a cash value account or a HELOC does not mean it’s ideal for every scenario.
The Problem with HELOCs and Velocity Banking
Using a HELOC to pay down a mortgage faster can make people feel empowered. It’s a complicated strategy to execute, and it makes everything feel faster. In reality, though, it’s just a complicated way of making additional mortgage payments.
In our HELOC report, the hidden truth is that only with extra payments to can the home be paid off faster. The HELOC simply disguises those extra payments, making people feel like they’re saving more money.
It is much simpler for the client to just make higher payments, instead of using the line of credit to pay down the mortgage, and then the complicated back and forth of paying the HELOC with income and paying expenses with the HELOC. This can even allow clients to pay down their mortgage faster than a velocity banking strategy because they’re not being burdened by an additional interest rate.
This is ultimately, however, a misplaced fear of interest cost. A longer mortgage gives more power to homeowners. Homeowners who pay their mortgage off over 30 years, for example, have more cash flow, as well as the power of inflation making payments feel lower over time. For more on why a longer mortgage is ideal, read our blog post on mortgages.
Using Truth Concepts for Velocity Banking “Proofs”
If your goal is to provide your clients with options that fit their financial desires, look no further than Truth Concepts. Our calculators are designed to help you analyze scenarios from all angles. For example, if you choose to see for yourself the best way for your client to pay down their mortgage, our Loan Analysis calculator can help. You can compare two loans over interest rates, payment strategies, and other factors. And while you can also compare time frames, read our 30-year mortgage article to learn why it’s important to compare mortgages over the same time frame.
Other calculators, such as Automobile Purchases and Funding, can help you assess payment methods for other scenarios. Each calculator in the Truth Concepts suite allows you to plug in real numbers so you can see which option has the desired results. That way, you can guide your client to fund purchases and investments using the right pool of money.
To get our most in-depth training on the Truth Concepts calculators, we encourage you to attend a Truth Training. You will spend three days amongst like-minded advisors, learning exactly how to use the calculators in real-time.