Arbitrage is not a new concept: whenever you buy an item and sell it quickly for a profit, you’re participating in some form of arbitrage. For example, let’s say you owned an antique shop. You might spend Saturday mornings on the yard sale circuit, looking for antiques that you could sell in your shop. When you buy an antique radio for $5 at a yard sale, and turn around and sell it for $25 at your antique shop, you’re involved in the process called “arbitrage”.
Another form of arbitrage would describe this interaction: let’s say a friend of yours handed you $5,000 for a year and charged you $50 to use the money. During the year, you could invest the money or put it in an interest earning savings account that’s preferably risk-free –- and as long as you earn more than the $50 it cost you to borrow the money, you will turn a profit when you return the $5,000 you borrowed.
So in short, it’s another form of leverage, or what you would call the practice of using “other people’s money” to make yourself a profit and to allow yourself to pocket some dough. The same method can actually be used with credit cards: you can borrow money to invest and turn a profit, the idea being that you make money by using the credit card company’s funds. In this case, you would effectively use borrowed money to invest (much like what happened during the subprime lending crisis and “no money down” era). While this practice is familiar to quite a good number of financial bloggers and financially shrewd individuals out there, it may not be something that many people have heard of.
Let’s answer a few quick questions about this:
Can you make money with credit card arbitrage? In theory, yes, IF you successfully qualify for the right combination of financial accounts to work with, if you have an eye for detail, and are an expert at managing, organizing and handling accounts.
But can you STILL make money with credit card arbitrage today? Given the current credit and savings climate, not likely. Opportunities are few and far between. But do read on to get more detailed insights on this matter.
Let’s go ahead and dissect this practice today.
What Exactly is Credit Card Arbitrage?
As mentioned, credit card arbitrage refers to borrowing the money from a credit card instead of a person, and there are no products involved that you must buy and sell at a profit.
There are two sides to the credit card arbitrage “coin”:
(1) a balance transfer credit card that gives you favorable terms and
(2) a savings account that is safe and with a good enough yield to reward you for your arbitrage efforts.
When you take a 0% balance transfer offer from a credit card company and deposit the money into a savings account or other form of investment that earns interest, and as long as the interest you earn is greater than the cost of borrowing money, then you’ll make a profit. And therein lies the challenge: making sure that you’ll actually find yourself in the black if you engage in this activity. To make it work, you’ll have to make sure that the cost of the use of borrowed money is minimized as you try to maximize returns from this money.
Here’s how it is supposed to work:
1. Find a risk-free investment or savings account that has a great rate. The rate of the stable income or savings account will also be important as this will dictate just how much money you’ll end up keeping in the end. It’s also imperative that you avoid putting borrowed money at risk (say in the stock market, where you can’t guarantee or control results), hence the choice of a high yield savings account to harbor your funds.
2. Find and qualify for a 0% balance transfer offer that allows you to write a check. Qualifying for the card may be trickier if the card company has tougher screening guidelines for its customers. Also, there used to be 0% lifetime APR offers, but they’ve gone extinct. Ultimately, card issuers hope that your balance continues to exist beyond the intro period expiration date so that they can begin to charge you their much higher regular rates on what’s remaining.
3. Deposit the balance transfer check into your interest-bearing, no monthly fee savings account (in #1).
4. When payments are due on the credit card, cover those monthly minimum payments with the funds you’ve placed in the savings account, leaving the rest of the cash in the account to earn interest.
5. When your balance transfer card is about to expire, pay the remaining balance off with what is in your savings account. You should be left with a profit from interest earnings.
What To Look For In A Credit Card
For the purpose of arbitrage, there are a couple of card characteristics you need to pay attention to:
1. Watch out for the APR. While using a 0% APR card is the most ideal, it is possible to perform arbitrage with a low interest card with a rate like 2% or 3%, provided that you find an investment or savings option which is going to pay you more interest than the card APR. In our current low interest climate, finding a stable yet liquid money account that yields over 2% is akin to searching for the proverbial needle in a haystack. So depending on the economic conditions, you may decide to simply stick to 0% card products.
The 0% balance transfer offers were plentiful right before the financial crisis, with many sporting 12 to 24 month intro periods. However, as a result of the crisis, those offers dried up and the CARD Act was consequently released, causing the credit industry to conform to tighter standards. Recently though, card issuers look like they’ve regrouped and have been releasing new card products with noticeable improvements, although balance transfer conditions are no longer as generous as they once were.
2. Seek lengthy introductory periods. Of course, the longer the 0% intro period, the longer you can keep the scheme going. Spend some time looking for 0% offers that are good for at least a year, otherwise you’ll probably not make enough to offset the costs of borrowing.
3. Check for restrictions on the 0% interest offer. Some card companies may require you to make purchases in order to maintain that 0% rate (especially if purchases are subject to a regular APR). Restrictions like these may render the scheme useless, so make sure to understand the requirements before proceeding.
4. Find out about the transfer fee. See if you can find a card with no transfer fee. But depending on card industry trends, you may find that such cards are somewhat of a rarity, as almost all of them now require a 3% to 5% transaction fee on transferred balances. Typically, if the fee is over 3%, you probably aren’t going to make much of a profit, but it all depends on how much money you borrow and the amount of interest the money will earn you.
A Card Arbitrage Example
Let’s go through an example to illustrate the risks and rewards of such a scheme. If you borrow $5,000 from a credit card with 0% interest for 12 months, but with a balance transfer fee of 3% — it is going to cost $150 to borrow the money. If you deposit the $5,000 into an account that earns 4% annually for 12 months, you will accumulate $203.71 in interest. In this example, you will profit $53.71. You can see how you completely ruin any chance of profit if you have even one late payment with the average credit card late payment fee of $35.
Now let’s tweak that example just a little: if you borrow $15,000 through 0% balance transfer checks for 1 year and deposited the money into an account earning 4% annually for 12 months, you would earn $611.12 in interest. The 3% balance transfer fee would cost you $450, leaving you with a profit of $161.12.
Risks and Challenges of Credit Card Arbitrage
In theory, it seems fairly easy to borrow money from credit cards and turn a profit, but the fact is, it’s no longer the “fad” that it once was. Arbitrage is not an easy way to make money because of these reasons:
1. Changes in the credit environment and the low rate climate are big reasons why this practice has faded in popularity. Card fees have been increasing while savings APYs have been falling. There simply is a dearth of great products out there.
2. Your credit matters. Even if you find the right card for your purposes, the card company may deem you ineligible for it. They’re pretty strict about accepting customers these days.
3. Your credit limit will dictate just how much you can borrow. Even if you do qualify for the best card deal in town, you can still end up with limited funds (from the card) to really make any meaningful money out of your planned transactions. Our examples above show how much of an influence your seed money has on the profits you will generate. Many cardholders used to get around this problem by using many cards for the scheme, which was a lot easier when credit was flowing fast and furious.
4. There are inherent risks to “playing this game”. Finally, some people who attempt credit card arbitrage make mistakes in the process. Mistakes in this game are costly! If you forget to pay a card bill or fall behind with your payments, you’ll be hit with late fees at a minimum. For some card introductory offers, a late payment may immediately trigger an interest rate increase, thereby neutralizing any gains you were aiming for.
So given all these caveats, this money making scheme may no longer be viable. Your time may be better spent evaluating other forms of investment.
Created August 12, 2007. Updated October 3, 2011. Copyright © 2011 The Digerati Life. All Rights Reserved.