I have had occasion to work with Linda Bustos, an editor for Creditorweb, an information
resource and Web site to help compare credit cards. I thought that I would share this guest post from her. It is excellent advice on an “investment strategy” called credit card arbitrage. I agree with Linda, by the way, that it is not really a very sound personal finance move in most situations. However, I do feel that if used sparingly and wisely as part of a vigorous and disciplined debt reduction plan, switching can work. But as an investment strategy? Not so much.
Enjoy the post from Linda Bustos:
If you have an address, chances are you’re receiving offers
for 0% APR credit cards on a regular basis.
Sure, these cards can save you a lot of money if you transfer a debt
from a higher interest credit card or credit line and pay down your entire
balance before the 0% becomes 12% or more.
But what if you faithfully pay off your bills in full every month – can
borrowing money at 0% interest and re-investing it actually make you money?
This is referred to as “credit card arbitrage” and it was
actually suggested to me by my credit card company in a desperate attempt to
get me using a low APR credit card again – one I had long paid off and have
since neglected to use. Since I don’t
carry a balance on my other credit cards and I don’t plan on making any major
purchases my savings can’t cover, the salesman asked me if I wanted to take a
cash advance on one of my higher interest credit cards, transfer the debt over
to a 0.99% card and invest the cash elsewhere.
I currently have a high interest savings account that pays
me 3.75%. If I did simple math I would estimate I could earn 2.76% on a few
thousand dollars for the 12 month introductory period. But it’s not that simple.
First of all, most balance transfer credit cards charge a
percent of your balance as a transfer fee. This is typically 2% – 4%. Unless
you are investing in something with higher interest than a savings account,
you’re not making any money. Of course,
the higher the return, the higher the risk – and if you carry a balance even
one day after your introductory period expires, guess what – you will be paying
12 – 25% interest or more.
Keep in mind if you’re thinking of investing in less-liquid
investments like bonds and certificates of deposit that you may not be able to
get your money back before your interest rate jumps. Meanwhile, you’ll be
making minimum payments on your low APR credit card each month, which also eats
away at any profits you think you’re making.
This tactic can also impact your credit score. Each inquiry on your credit report (for a new
credit card approval) can lower your score.
Plus, when you max out your higher interest card, your debt-to-credit
ratio rises, making you a higher credit risk.
Sure, you transfer that to the low APR credit card and clear your first
card’s balance, but you’re paying credit with credit – and creditors can see
this when they check out your report.
This hurts when the creditors are deciding what interest
rate to charge you on auto and home financing.
You could wind up paying higher interest for 25 years on a $300,000 home
because you wanted to make a couple hundred dollars over a year’s time with
credit card arbitrage.
And don’t forget that you will likely pay interest on your
cash advance the day you take it out from your original credit card, and at a
higher rate than your normal purchases.
You may end up paying for a week’s interest while you get the balance
transfer sorted out.
If that’s not enough, consider that one late payment is
grounds for your credit card company to revoke your low APR and bump you up to
a high interest rate. Even if your late payment was for another credit card or
loan if your terms include a “universal default” clause.
Let’s assume after all that you end up making a profit after
all. Your earnings are taxable income while the monthly payments, transfer fees
and any interest you paid out are not tax deductible. D’oh!
Even if your credit card company gives you the impression
you can get ahead with taking out more credit card debt, don’t be fooled!
Credit card arbitrage is not a good plan to get ahead.