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

    A card issued by a financial company giving the holder an option ...
  2. Credit Card Balance

    The amount of charges, or lack thereof, owed to the credit card ...
  3. Secured Credit Card

    A type of credit card that is backed by a savings account used ...
  4. Balance Chasing

    The gradual lowering of a consumer’s credit limit by a credit ...
  5. Credit Utilization Ratio

    An input used in determining a person's credit score. It is the ...
  6. Terms And Conditions (Credit Card)

    A formal statement of the rules and guidelines that govern the ...
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

    Should You Use Credit Cards To Fund Your Business?

    We give you 4 reasons to consider using a credit card instead of a business loan to fund your business, and how to be smart about it.
  3. Personal Finance

    Best Credit Card Features For Students

    Students should look for credit cards that charge no annual fees, have a low introductory interest rate and offer rewards or money.
  4. Personal Finance

    How Many Credit Cards Should You Have?

    National stats indicate most consumers have three or more cards - are you one of them?
  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

    Best Credit Cards For People With Poor Credit Scores

    There are still ways you can build credit with a credit card, even if you have bad credit.
  7. 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.
  8. Personal Finance

    Cut Credit Card Bills By Negotiating a Lower APR

    Reducing the rate charged on your credit card balance is the first step to getting out of debt.
  9. Personal Finance

    Credit Cards For People With Bad Credit

    Yes, you can get a credit card and start repairing your credit history. But brace yourself for low credit limits, sky-high interest and staggering fees.
Trading Center