On Sam Kwak’s YouTube account, the most popular video has the highest views at 3.5 million. It’s not a high-tech device all credit types welcome. An hour of Kwak rambling on. His only tools were a few sheets of printer paper and a black Sharpie. That’s what makes it so appealing to viewers: the promise of a mortgage paid off in a short period.
With an empty office stretching out behind him, he remarks, “Mortgages sort of stink.” He’s seated in a glass-encased conference room.
After attending a lecture, Kwak, now 28 years old, recorded the video in September 2017. It promises that a 30-year mortgage may be paid off in only seven years, saving the borrowers thousands of interest. Since it was published in May of this year, an updated version has been read over 900,000 times. This includes a spike in traffic around the time of the coronavirus outbreak in March.
Kwak and his brother Daniel are two of the most well-known proponents of a method known as “velocity banking” or “debt acceleration” because of these figures. The strategy is not new, but it has recently taken off on YouTube, where hundreds of lessons have been posted, several of which have received over 100,000 views.
Most of the videos, like Kwak’s, are pretty straightforward to make. With the help of a whiteboard and Christmas lights, a lady leads us through the procedure by sketching stick figures on the board. A guy is entering an Excel spreadsheet in another video. Powerpoint presentations depicting a borrower with a modest income and significant savings are often reused.
In the tone, it seems as if you’ve been given a secret that will give you an advantage over your lender. According to critics, “robbing Peter to pay Paul” has characterized the strategy.
Spreading your money across various debt instruments is the fundamental premise to reducing interest costs while increasing the amount that goes toward paying down your mortgage’s principle. However, for this strategy to succeed, you must spend less than you make. It’s possible that instead of getting a low-cost mortgage, you’ll be saddled with a large debt from an expensive line of credit if anything goes wrong. When things go terrible, you might lose your home if you don’t take action.
Even though the gimmick teaches you a few things about how mortgages operate and how to make yours work better for you, it is a very dangerous game of what experienced investors term arbitrage, or taking advantage of slight differences in pricing or, in this instance, interest rates.
Denver-based mortgage expert Nicole Rueth quizzes you to determine whether you’re financially competent. According to her, the method may be effective in certain situations, but the outcomes can be “devastating” if it is not carried out correctly. “The minute you collapse is the time the house of cards comes crashing down.
Velocity banking: a how-to guide (and what could happen)
Step 1: Getting a mortgage
Assuming you have a $300,000 mortgage, you’ve committed to paying your lender $1,265 a month for 360 months at a fixed 3% interest rate. If you finish the debt, you’ll pay $155,000 in interest.
While you were paying for your property, you effectively gave the bank a second mortgage.
Nevertheless, borrowing money to buy a house has never been more affordable. In December, a record low of 2.68 percent was the average for benchmark mortgage rates. To put things in perspective, in the 1980s, rates peaked at 18.45%. This means you are getting a fair bargain if you can afford your monthly payment and opt to stop here.
Step 2: Get a home equity line of credit (HELOC).
HELOC (Home Equity Line of Credit) is the next step. When you use a HELOC, you’re borrowing against the equity in your house rather than a credit card company. Borrowers often use HELOCs to fund home repair projects or other significant one-time or recurring costs.
Despite the reduced interest rates, HELOCs are not risk-free investments. Home equity lines now have an average interest rate of 3.92 percent, although the variety of rates is wide. A HELOC’s interest rate is also adjustable, which means it resets after a specific starting time.
There is a strong probability that your interest rate may rise at some point in the future, making the arithmetic behind the velocity banking plan more difficult. Although lenders have been known to terminate credit lines when the economy is poor, that has not been the case during this current slump. If you can’t keep up with your payments, your lender has the option of foreclosing on your home.
Step 3: Pay off your mortgage using the HELOC.
Once you have both of your loans in place, the game starts. If you’ve got a home equity line of credit (HELOC), velocity banking advocates recommend you utilize it to pay down some of your mortgages. “Chunking” is a term used by proponents.
If you borrowed $10,000 from your HELOC and used it to pay your mortgage, you’d pay it off two years instead of three years. Your mortgage would be paid off 18 months earlier if only you paid an additional $14,000 in interest.
How? Monthly interest payments on a mortgage are computed. Your lender divides the result by multiplying your outstanding balance by your mortgage rate by 12 to arrive at the amount you owe. To put it another way: the first month’s payment on our hypothetical mortgage would cover $750 in interest while the rest went toward the principle.
A little more of your loan total goes toward the principle each month with regular payments. You may speed up the amortization process by paying more in this example, by taking out a HELOC.
Step 4: Reduce your HELOC debt to zero as quickly as possible.
Even if you pay off your mortgage with a HELOC, you’re merely shifting the obligation to a new kind of debt. On the other hand, Velocity banking proponents consider this the strategy’s greatest asset.
HELOC interest payments are based on the average daily amount since the loan is ongoing and may be repaid at any moment. Even after spending two months fiddling with an Excel spreadsheet, Kwak finally realized that keeping your account balance as low as possible during the month saved you money on interest. He advises utilizing any available funds to decrease your home equity line of credit.
He suggests that you place all of your costs on a credit card to keep them down for a more extended period. Paying your credit card bill in full each month results in a one-month interest-free loan period. You’ll want to be very cautious with this one. If you miscalculate your credit card APR, you might end yourself with a significant amount on the highest-interest debt you can find.) It’s like juggling three balls: a mortgage, a home equity line of credit, and a credit card.
To succeed, “it appears to be the math aspect of it; how you arrange when money comes in and costs go out tends to be the determining component,” says Kwak.
On the other hand, Kwak concedes that the whole procedure only saves a few dollars. Follow his and other people’s instructions step-by-step to see any progress.
If the technique is to have any effect, the amount you owe on the line of credit must decrease over time. This can only be achieved if you continuously spend less than you earn on necessities. The quicker the procedure goes, the more you save. For example, many videos utilize a $60,000-a-year earner who holds at least 25%.
The personal savings rate in the United States was roughly 8% in February 2020, right before the coronavirus struck. Even if you’ve already saved enough money for an emergency fund and retirement, this technique may still be a good fit for you. There are, however, significantly more straightforward alternatives.
When and how to get out of a mortgage early.
Using a windfall like a tax return, a bonus, or a stimulus check, you can recreate the advantages of “chunking” by paying down your mortgage. You may enjoy similar benefits to the HELOC example by putting $10,000 toward a $300,000 mortgage, for example. Just tell your lender that the money will be used to pay down the principle, not interest.
If you don’t plan on getting a large sum of money shortly, an additional $50 a month on the $300,000 mortgage (so $1,315 instead of $1,265) will save you more than $10,000 in interest. Automate periodic additional payments with your lender so that you don’t have to worry about them.
The Mortgage Professor blog of former University of Pennsylvania finance professor Jack Guttentag has a handy additional payment calculator. Guttentag cautions that “big savings” need “huge payments” in a blog post. “The key is to come up with a payment schedule that works for you.”