What are the risks of credit card arbitrage?
Is it really possible to make “money for nothing” as Dire Straits sang in their hit song from 1985? People who take advantage of credit card arbitration say yes. But is it a smart way to beat the credit card companies at their own game, or just a risky way to rack up high interest debt and hit your bankroll? credit rating In the process?
What is credit card arbitrage?
Arbitration is the process of simultaneously purchasing a investment vehicle at a lower cost and resell it at a higher price while taking advantage of the price difference. Credit card arbitrage involves borrowing money from credit card companies and then investing that money in an instrument that offers a higher interest rate than what you pay.
Here’s how it works: You receive an offer in the mail from a credit card company promising you a zero percent interest rate or a low interest rate to transfer your balance from an existing card. You complete the paperwork and prepare one of the pre-printed checks the company sends with the offer to your name. Or you complete the online application and indicate where the payment will go.
Then you do some homework to find a high return savings account, CD or other instrument offering a higher interest rate. From there you invest the money, making at least the minimum payments every month on time and, when the lower initial teaser rate expires, withdraw the money, pay the balance owed on the card and keep the difference as profit.
The risks of credit card arbitrage
It’s an easy way to make money for free, right? In reality, it is not that simple and it may cost you more than you can afford.
Supporters of credit card arbitrage point out that the zero percent rate, or low interest rate, allows consumers to get Capital city for free or at low cost. And if the borrower repays the full amount on time, it may demonstrate that they are able to manage and repay the debt, which in turn can potentially increase their credit rating. But as Avi Karnani, co-founder of financial planning website Thrive said in a phone interview, “it’s a gamble like no other.”
Here are some of the main risks of using your credit card to fund your investments.
Risk 1: Bad investments
One of the assumptions behind credit card arbitrage is that it is possible to find a “safe” investment that will earn you a significantly higher rate of return on the money you borrowed to invest. But in a tough financial environment, these vehicles are harder to find.
“The people who traditionally do well in arbitration are investment professionals,” Karnani notes. “Why should someone recommend it to the average person as a way to achieve a relatively small amount of savings?” ”
When credit card companies start pulling back zero percent offers or suddenly change the terms to charge you more on your loan, the 3% interest rate on a high-yield savings account won’t. will bring you no profit. And don’t just look at the interest you might earn. You need to know the terms of the investment you are making. If you were to withdraw your money earlier, would you be charged a penalty? How?
Risk 2: Create a debt habit
An often unintended consequence of engaging in behaviors such as credit card arbitrage is actually psychological in nature. “It encourages terrible financial behavior,” Karnani explains. “It’s not financially healthy for people to get used to seeing large numbers on their credit card statements and having high debt levels.”
Risk 3: Default on the loan
The money you get from the credit card company is a loan. If you do not repay the business in accordance with the loan terms, you are in default. When this happens, you will be charged a late charge but, more importantly, the credit card company can immediately change the terms of your loan and charge a much higher interest rate, think 19% to 29%. Costs can go up quickly, not only wiping out any financial gain, but actually weighing you down with debt that could take months or years to pay off.
Unexpected life changes can quickly wear out liquidity you may have planned to use to make the monthly payments. “Credit card arbitration works great on paper, but the problem arises when someone suddenly loses their job, becomes seriously ill or has a serious accident,” says Kendall Peterson of CreditWhisperer.com. “It puts you in a situation where, overnight, you owe more money than you can afford. No one is predicting that stuff will happen to them.”
Risk 4: Credit score setback
Engaging in credit card arbitrage could hurt your credit score in several ways:
- Opening of a new credit line usually hurts your score.sese
- Borrowing money on the new card increases your usage rate (the amount of credit you have over how much you currently use). A higher utilization rate translates into a lower credit score.sese
- But debt-to-income ratio (DTI) is not on your report, a high DTI may affect your ability to get loans such as a mortgage.sese
- Making a single late payment can spell disaster, as timely payments make up about 35% of your overall credit score.sese
Risk 5: Rule changes
According to Curtis Arnold, founder of Cardratings.com: “The rules of the game have changed. It’s a tough environment. What was considered difficult and fast in the credit world is changing overnight. Credit card companies don’t have to give notice, and you may not even realize the terms have changed. “You throw out a letter that looks like spam, but it actually informs you of important changes to your account,” says Arnold.
Companies can change your payment due date, shorten your billing cycle, increase your interest rate and add fees without you knowing about the change. The implications can be serious. “Let’s say you borrow $ 10,000 and overnight the company removes the supply cap,” says Arnold. “Suddenly you’re paying 3% interest on your loan balance, which means you now have to pay at least $ 300 for the loan; the rate of return on your investment must match in order for you to make a profit. ”
The bottom line
While some people may have the financial discipline and the ability to engage in credit card arbitrage, there are significant risks that should not be overlooked. “The days of making a lot of money that way, it’s a risky business. However, there are still some offers that might make sense for people with the right approach and the right discipline,” explains Arnold.
To have the greatest likelihood of success, Arnold gave the following tips.
- Carefully read the terms of the offer from the credit card company.
- Do the math to make sure that once the expenses are paid, you will pay a reasonable amount return rate.
- Set up an automatic payment system for the monthly payment.
- Join an online social media group to stay on top of the latest industry trends, pitfalls and tips.
- Look for free balance transfer offers expiration dates. These offers may have a higher interest rate, but you can lock in that rate until you pay off the balance in full, significantly extending your investment. temporary horizon.
- Have a Plan B to quickly access cash savings and pay off the loan in full, if needed.
If all of these steps are followed, you have a better chance of making credit card arbitrage work, but it is still a risky maneuver.