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Investment Tip of the Day
Credit Card Arbitrage
Every once in a blue moon there is a credit card offer too sweet to pass up. One in particular is when a credit card company offers a 0% balance transfer with no strings attached just by signing up to have their credit card. Who wouldn’t take up that offer?
The definition of arbitrage is: a market activity whereby a commodity is quickly bought and sold for a profit that exceeds transaction costs.
The term “credit card arbitrage” comes about when you take advantage of some offer by a credit card company and use the proceeds in a way that nets you a profitable return. So in this example taking advantage of the 0% balance transfer offer and placing the money into a high-interest savings account would be one of many ways of leveraging credit card arbitrage.
This can only work if interest rates (or other means you are using to raise a profit) are greater than the transaction costs. However, be careful to always make your payments on time. Although you aren’t being charged interest (if it’s a 0% offer) or a relatively small one you still have to make monthly repayments so that the credit card company knows you didn’t just run off with their money. If you do miss a payment you can expect your offer will end abruptly and you will lose any further profit that was occurring under this arbitrage. This is what credit card companies are hoping — that you forget and make a mistake.
Most people that take advantage of credit card arbitrage do so through balance transfer promotions such as the famous and long-running 0% for 18-months MBNA Platinum MasterCard promotion. Also, although interest rates may be low or at 0% the company may charge you a balance transfer fee to initiate the request. This is usually at a fixed percentage to the balance you want to transfer (typically 1%). So before you jump into the deep end make sure to do your research and find out what the true cost will be onto you and how much profit you can expect when the offer ends, when you must repay the entire principal back, or risk paying finance charges at an elevated credit card interest rate.
Applying for credit cards to take advantage of arbitrage also risks adversely affecting your credit score. In simplistic terms, part of your credit score is determined by the number of enquiries to your history. The more requests for your history, which happens each time you apply for a new credit card, the lower your score becomes. Also the more credit you have available can also affect your ability to secure other types of loans like mortgages because it tends to look like you have an ability to amass large debt (a high credit balance availability).
But overall the risk is well worth it seeing as how if you are consistent with your repayments and properly plan how you intend to make a profit it is a no lose situation.