Posted on Wednesday 12 November 2014
We all know by now that credit cards are risky. Without good financial discipline, it is very easy to bury yourself under a mountain of debt, and very difficult to dig your way back out . But what if there was a way to make your credit card work for you?
Not with rewards, or free gift vouchers, but cold, hard cash. There are some who believe that credit card arbitrage can do exactly that, but can it really be so simple? Do the rewards outweigh the risks? How Does Credit Card Arbitrage Work? Arbitrage is the process of buying something for a low price and simultaneously selling it for a higher price.
Applied to credit cards, it means using low or even zero introductory rates to make money. After signing up to the introductory credit card offer, you borrow money on the card and invest it in a financial product, such as a high-interest savings account, with a higher interest rate than the credit card. Make at least the minimum payment on the card every month to avoid penalty fees. Also try to do this before the holiday season so it's out of the way. It's a bit different than medical emergency loans by the way.
At the end of the introductory low interest rate period, withdraw your money from the savings account, pay off the credit card, and keep the difference. After that, sit back and enjoy your free money. Is There A Downside? It should not be a surprise that there are several risks and drawbacks to credit card arbitrage, some of them severe. After all, there is no such thing as a free lunch. Not the best money handling tip for someone in their 20s but it may work.
The first is that the returns of credit card arbitrage are actually quite low. The golden age of credit card arbitrage took place before the financial crisis of 2008, when zero-interest credit cards would arrive in the mail and you could get an interest rate of more than 2% on a high-interest savings account.
Nowadays, introductory credit card rates are fewer and further between, and high interest savings are largely a thing of the past, even after introductory rates. With low interest rates, a $10,000 arbitrage plan might only make you $100 in a year after balance transfer fees. There are of course more lucrative investments than a savings account, but they are either more restricted or just riskier.
Restrictions on withdrawals can make arbitrage expensive or impossible, while risky investments can lose money and leave you in debt to the credit card company with no way of paying it off. Second, it requires good research skills and iron discipline. Payments and withdrawals will have to be made precisely on time.
If you have trouble sticking to a budget every month and paying all of your bills on time, arbitrage is not for you. It can be useful to set up automatic minimum payments on your card to avoid penalty fees. If you miss a payment, penalty fees kick in. If you miss the big payoff before the introductory rate ends, get used to living under a mountain of debt, because you will be there for a while.
Even if you trust yourself to make payments, though, you will also need to read the small print on that introductory credit card offer. Once again, there is no such thing as a free lunch. Introductory card offers often include balance transfer fees which can even push you over your credit limit if you try to max out the card, as they add on to the balance you requested. Credit card companies make money on introductory offers from people who didn’t read the small print. Third, arbitrage can hurt your credit score .
In fact, if your credit score isn’t high enough, you might not be able to experiment with arbitrage in the first place. While credit options exist for people with bad credit or no credit , credit cards are not always among them. The problem with arbitrage from a credit score perspective is that pushing your introductory credit card to the limit to make the most of meager returns will increase your utilization ratio.
A high utilization ratio looks bad on your credit report and will affect your creditworthiness. Even if succeed at credit card arbitrage and make money without getting caught by penalty fees or increased interest rates, your credit score will dip. Is credit card arbitrage worth it, then? Currently, almost certainly not. Unfavourable interest rates make the returns extremely meager next to the risks, and the risks are substantial. Although there are lots of ways of making money like creating a Youtube channel, creating a savings app perhaps or even showing Canadians how to save money, etc. Credit card arbitrage might be something you want to learn about but not really put into practice. If you are a parent thinking of doing this, there are better ways for parents to save money than this.
After all, it's not "financial" science like comparing Roth IRA vs 401k or something similar. Not getting involved with any kind of arbitrage let alone credit card arbitrage is just good common sense.