Credit Card Arbitrage: Free Money or Risky Bet?

Credit card arbitragers turn the tables by taking advantage of the special introductory offers on many cards to make money for themselves. These financial swashbucklers see the 0% teaser rates on certain credit cards as free capital – capital which can be invested to earn a risk-free return.

 

It’s a nice idea, isn’t it? A savvy consumer, using nothing more than a credit application and a spreadsheet, beating the big, sophisticated credit card companies at their own game. Hunter becomes hunted, predator becomes prey. But is credit card arbitrage actually doable, or just one of those ‘free money’ myths that always seem to persist?

 

The answer is yes, it is doable – in 2014, credit card arbitrage is alive and well as the Visas, MasterCards and American Expresses of the world compete for new business with 0% APR introductory offers.

 

Whether it is sensible is another matter – credit card arbitrage, you see, is not as easy as it first appears – one small mistake can spell disaster, turning easy profits into big losses and damaged credit.

 

 

The concept is pretty simple – find a balance transfer or cash-advance credit card offering a 0% introductory interest rate for six, or preferably even twelve months, invest the funds from the card into an instrument that earns a decent, risk-free return, such as a high interest savings account, and watch the free money roll in. The gap, or “spread” between the cost to borrow the funds (zero or close to zero) and the interest you earn from the savings account goes straight into your pocket – hence the term arbitrage.

 

Of course, along the way you’ll have to diligently make the minimum monthly payments and, when the 0% introductory rate expires, promptly pay off the card after you’ve booked your profits.

 

 

Balance transfer cards work best. Many will allow you to transfer funds directly from the card’s credit line to your bank account, essentially giving you a low or no-interest loan. In 2014 we’re seeing several cards with 0% interest on balance transfers, with the MBNA Platinum Plus MasterCard probably being among the best.

 

With the MBNA Platinum Plus MasterCard, you simply designate a transfer of funds from the card to an account of your choice – from there, you can invest the money however you wish.

 

Assuming your credit line is $30,000, if you invested the money at 3% interest you could earn a return of $900, minus any fees, of course.

 

In finance, arbitrage is thought of as being essentially risk free, but with credit cards, it’s anything but. Being late on even a single payment will reset the credit card account’s interest rate from zero or close to zero to the double digits, quickly turning your easy profits to steep and needless losses.

 

Credit card arbitragers should also park the borrowed funds in a safe investment vehicle like a savings account or money market fund, rather than riskier securities like stocks or high-yield bonds. Placing borrowed money in risky investments will spell disaster if you incur losses. You could easily end up with thousands of dollars in high-interest credit card debt with no way to pay it back! And don’t even think of using borrowed money from your card for a levered investment, where even a small loss could wipe out your principal. Let’s just say credit card debt is not something you want to put into a 3x levered ETF!

 

Arbitragers also usually find that their credit score takes a hit, even if they do make their payments on time. That’s because borrowing a large sum from a new credit card increases your credit utilization ratio(how much credit you are using versus how much credit is available). Higher credit utilization negatively impacts credit scores.

 

 

(1) Get the card with the longest low-interest introductory period you can find. The longer you can keep your super-low interest rate loan before it resets, the more time you’ll have to conduct your arbitrage. Aim for a period of at least six months, and preferably one year. This gives you enough time to be able to make enough of a profit to justify the hassle of the arbitrage in the first place.

 

(2) Carefully read the card’s fine print for hidden fees or spending minimums. Some cards tout 0% interest on cash advances and balance transfers but require you to make monthly purchases in order to maintain the 0% rate. Others have hidden surcharges that could eat into any potential profits you might make from the arbitrage scheme. A surcharge of just 2% would render most arbitrage schemes pointless, even if you’re getting a 0% introductory APR. Read all the fine print so you don’t get sideswiped by surcharges.

 

(3) Borrow enough from the card to justify the arbitrage in the first place. If your credit limit is under $10,000, an arbitrage scheme makes very little sense. Even if you make a 2-3% spread on the borrowed money, your return won’t be enough to justify the arbitrage.

 

(4) Set Up an Automated Payment Schedule. To err is human – especially when it comes to credit cards! Take yourself out of the equation by setting up automatic monthly payments. Remember, just one late payment will bring your perfectly thought-through arbitrage plan crashing down.

  

 

It really depends on your risk profile and how diligent you are with your finances. It’s true that there are probably easier, less risky ways to make some extra cash. Nonetheless, a fascination with credit card arbitrage continues to persist – consumers seem to like the idea of free money!