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.

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