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This Viral "Hack" to Pay Off Your Mortgage Faster - Debunked

The "Velocity of Banking" (or "Infinite Banking") Concept

...promotes the idea of using a line of credit (often a home equity line of credit, or HELOC) with a higher interest rate to pay off a lower-interest mortgage, with the belief that this will accelerate the mortgage payoff and save on interest payments. Let's break down why this might not work.

Scenario:

  • Mortgage balance: $150,000 at 3% interest.
  • House value: $350,000.
  • Line of Credit (HELOC): $100,000 limit at 8% interest.

The Velocity of Banking Concept:

The idea is to take out a large portion (or all) of the HELOC, which has an 8% interest rate, and use that money to pay down or pay off the 3% mortgage. Then, instead of paying off your mortgage directly, you aggressively pay down the HELOC, and because HELOCs typically allow for flexible payments, the concept suggests that by doing this, you can pay less interest over time. Here's why this doesn't work well in practice.

Why It Doesn't Work:

1) Interest Rate Mismatch:

  • You're borrowing money at 8% interest to pay off debt at 3% interest. That’s a 5% higher rate on the HELOC. Even if you're paying down the HELOC more quickly than you would your mortgage, the higher interest rate on the HELOC means you’re accumulating more interest than you would on your original mortgage.

    Example: If you pay $100,000 from the HELOC toward the $150,000 mortgage:

      • The HELOC is now $100,000 at 8% interest, while only $50,000 of the mortgage remains at 3%.
      • HELOC interest: $100,000 × 8% = $8,000/year in interest.
      • Mortgage interest: $50,000 × 3% = $1,500/year in interest.

    By switching debt to the HELOC, you’re paying $6,500 more per year in interest compared to just sticking with the mortgage.

    2) Interest on HELOC is Compound, Mortgage is Simple:

    • Mortgages typically use simple interest: interest is calculated on the principal balance and is fixed over time.
    • HELOCs generally use compound interest: interest can accrue on the unpaid balance every month, making the actual cost of the loan grow faster if you don’t aggressively pay it down.

      This means that even if you make aggressive payments on the HELOC, you're likely paying more total interest than you would on your fixed-rate mortgage.

      3) The Cash Flow Trap:

      • The idea assumes you have substantial cash flow to throw at the HELOC to pay it down faster. However, life often gets in the way (unexpected expenses, emergencies), which could mean you’re stuck with a balance on the HELOC for longer than anticipated.
      • Since the HELOC has an 8% interest rate, if you can't pay it off quickly, you’re stuck paying that higher interest for an extended period. This defeats the purpose of "velocity" if you don't have the consistent income to aggressively reduce the HELOC balance.

      4) Risk of Variable Interest Rates on the HELOC:

      • HELOCs typically come with variable interest rates, meaning your 8% interest rate could rise over time, further increasing your borrowing costs. In contrast, your mortgage rate of 3% is likely fixed, making it much cheaper over the long term.
      • If rates go up, you could be paying 9%, 10%, or more on the HELOC, while your mortgage remains at a low 3%.
      1. Transaction Costs and Fees:
        • HELOCs often come with fees—such as annual fees, origination fees, and closing costs—while your mortgage doesn’t require any new costs if you just keep paying it down.
        • These fees can add to the cost, further negating any potential savings you might think you’re getting from the strategy.

      A Better Approach:

      In this example, it’s far better to simply keep paying down the 3% mortgage. You could also make extra payments on the mortgage if you want to accelerate the payoff, which would save you interest in a much more effective way without introducing higher-interest debt into the equation.

      If you want to use the HELOC, it might be best saved for short-term liquidity needs or home improvements that will raise the value of the property—not to replace low-cost debt like a mortgage.

      Conclusion:

      Using an 8% HELOC to pay off a 3% mortgage is a losing strategy because the higher interest rate on the HELOC makes you pay far more interest over time. The premise of "velocity" doesn’t add up when you factor in the basic math of interest rates and cash flow. It’s better to stay with the lower-cost, fixed-rate mortgage and avoid the risk and higher costs associated with a variable-rate HELOC.

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