DEFINITION of 'Credit Card Arbitrage'

Borrowing money at a low interest rate from a credit card then investing that money at a higher interest rate to try to make a profit. The lowest risk and most common type of credit card arbitrage entails taking advantage of a 0% introductory APR balance transfer offer to borrow thousands of dollars from a credit card for the duration of the introductory period, often 12 or 15 months. The borrower then places all of this money in a higher-interest but no-risk vehicle, like a savings account, money market account or certificate of deposit, where the interest rate might be 1% to 5%, depending on market conditions. As long as the borrower makes all the required minimum monthly payments on the credit card on time and repays the balance in full before the introductory period expires, he or she will turn a profit from credit card arbitrage.

BREAKING DOWN 'Credit Card Arbitrage'

There are many ways borrowers can make less than they expect or fail to come out ahead when attempting credit card arbitrage. The interest earned by placing the money in a bank account will be taxable, which reduces earnings. Suppose you borrow $5,000 from your credit card at 0% and invest it in a 12-month CD (certificate of deposit) paying 2% interest. You would earn about $100 over the year. If your marginal tax rate is 25%, you’ll pay $25 in taxes on your $100 interest income, and you’ll net $75 from the credit card arbitrage.

The amount of money you might earn from this strategy may not be worth the risk. If you fail to make a minimum monthly payment on time on the $5,000 credit card balance, you will usually lose the 0% introductory APR and incur a late fee. Suddenly, you could find yourself with a $25 late fee and a 30% interest rate. That’s about $4 in interest per day on your $5,000 balance. You’ll have to quickly pay it off to end the interest charges. But your 12-month CD has an early withdrawal penalty of 120 days’ interest, which is about $25. In a best case scenario where you catch your late payment mistake early, you’ll still manage to break even, but all the time and effort you spent on credit card arbitrage will have been wasted.

The late payment, increased credit utilization and new credit line can also hurt your credit score, making it harder to get the best rate on a future loan that’s more important, like a mortgage.

RELATED TERMS
  1. Credit Card Balance

    The amount of charges, or lack thereof, owed to the credit card ...
  2. Purchase Rate

    The interest rate applied to purchases made with a credit card.
  3. Credit Card

    A card issued by a financial company giving the holder an option ...
  4. Universal Default

    A practice whereby a credit card issuer increases a credit card ...
  5. Terms And Conditions (Credit Card)

    A formal statement of the rules and guidelines that govern the ...
  6. Business Credit Card

    A credit card intended for use by a business rather than for ...
Related Articles
  1. Personal Finance

    Everything You Need To Know About Credit Card Rates

    Understanding credit card rates will help you choose the right credit card, and avoid any unpleasant surprises.
  2. Personal Finance

    Terrible Credit Score? Try These Credit Cards

    When your credit is less than stellar you have fewer choices. But some are still better than others. Here's our read on which cards to get.
  3. Personal Finance

    How Credit Cards Affect Your Credit Rating

    The average American household has four cards, but does that mean more is better?
  4. Personal Finance

    7 Factors For Comparing Credit Cards

    It's good to find a credit card that fits your lifestyle, but read the fine print to make sure you're not overpaying for the benefits.
  5. Personal Finance

    3 New Types Of Credit Cards To Look For

    These three types of credit cards are becoming popular with customers looking to pay less fees and build up their credit scores.
  6. Personal Finance

    4 Unexpected Things That Lower Your Credit

    It's important to maintain a good credit score. Discover what could be lowering it without your knowledge.
  7. Personal Finance

    Take Control Of Your Credit Cards

    The plastic in your wallet doesn't have to hurt your finances. Learn how to manage it responsibly.
  8. Personal Finance

    The Pros And Cons Of Balance Transfers

    Do the math before you assume that transferring your credit card balance to a lower rate card will save money. It could – or it could cost you.
  9. Small Business

    How to Use Small Business Credit Cards

    A small business credit card can be a convenient way to increase your company's purchasing power, but must be carefully managed.
RELATED FAQS
  1. How do secured credit cards help me build my credit score?

    Find out how secured credit cards function and why they can be very useful for those looking to build or rebuild their credit ... Read Answer >>
  2. Do balance transfers hurt your credit?

    The extent of the hit to your credit score depends on credit utilization. Read Answer >>
Trading Center