What is Credit Card Arbitrage
Credit card arbitrage refers to the process of borrowing money from a credit card at a low interest rate and 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 zero percent introductory annual percentage rate balance transfer offer to borrow thousands of dollars from a credit card for the duration of the introductory period, which is often 12 or 15 months. The borrower then places this money in a higher interest but lower-risk vehicle, like a savings account, money market account or certificate of deposit, where the interest rate might be one percent to five percent, depending on market conditions.
BREAKING DOWN Credit Card Arbitrage
Credit card arbitrage has a higher likelihood of being successful if a 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. Even then, though, the amount of money one might earn from this strategy may not be worth the risk.
Borrowers often make less money than they expect when attempting credit card arbitrage. Suppose you borrow $5,000 from your credit card at zero percent and invest it in a 12-month CD that pays 2 percent interest. You would've earned about $100 in interest income at the end of the 12-month term. However, your $100 will be taxed at both the state and federal level, and the interest income tax is higher than the more favorable capital gains tax rate. So, for 2021, an investor in the 24 percent federal tax bracket with $100 in CD interest income will be taxed $24 at the federal level, plus whatever the investor’s state tax rate is. In other words, expect to lose up to one-third of your credit card arbitrage earnings to taxes.
Potential Downside of Credit Card Arbitrage
If you borrowed $5,000 from your credit card at a zero percent introductory rate but then failed to make the minimum monthly payment on the credit card balance, your arbitrage opportunity is most likely history. If your payment is late, you will likely lose the 0 percent introductory APR, be charged a $25 late fee, and see the rate on your card skyrocket to 30 percent. That’s about $4 in interest per day on your $5,000 balance, which you’ll have to quickly pay off to end the interest charges. Additionally, if you have to withdraw your CD before maturity, you’ll have to pay a withdrawal penalty of 120 day's interest, which is about $25, Taken together, the late payment, increased credit utilization and new credit line can hurt your credit score, making it harder in the future to get the best rate on a loan like a mortgage.