Credit card debt has become a popular subject among families struggling with their finances. Utilizing compound interest rates, credit card companies can make getting out of debt seemingly impossible. However, many savvy consumers have found ways to turn this around on the credit card companies. Using the idea of credit card arbitrage, many have begun to profit from interest gained on their credit cards. Others, however, have also suffered severe financial backlashes.
What is Credit Card Arbitrage
Credit card arbitrage works by allowing consumers to take advantage of a credit card that has a very low interest rate or lacks one altogether (usually 0% APR for a promotional period, such as one year). They deposit the funds borrowed from the credit card into an account that yields a high interest rate. Each monthly payment is then made on time every month. Whenever the end of the payment period has been reached, or a change in the interest rate is looming (i.e. due to the end of a promotional period) the money is then withdrawn from the bank to pay off the balance. The interest accrued by the savings account becomes a profit for the consumer.
This may sound like a simple and lucrative process, but there are many risks that must be considered. Credit card interest rates can typically change with little or no warning. This is especially true whenever a payment is missed or paid late, at which time the rate typically soars. Any factor that could lead to a missed payment, from a family emergency to a lost job, will quickly void any chance of profitability. It’s also important to ensure that you will not be charged periodic fees for using the card. If you need to acquire checks from the credit card company in order to deposit the funds into your savings account, it’s also important to ensure that no extra fees accompany those checks.
How Much Can You Make With Credit Card Arbitrage
The amount of money that can be made will depend on the total line of credit available. For the average consumer holding a credit card, this will typically mean a small return. The total amount earned is already limited to the interest rate of the credit card and the small interest of the credit card (if there is one) will lower it even further. The more money that can be borrowed, the higher the interest return will become. However, a greater balance also means a higher monthly payment. Many people also consider using high yield checking accounts for this process as well.
Credit Card Arbitrage Risks
Some risks also exist with high yield savings account. One of the most important considerations that many people overlook is the possibility that a fee may be charged if the account owner attempts to withdraw funds before a certain period of time. Some of these accounts will also charge maintenance fees. The initial interest on a savings account can be volatile (especially if it is dependent on the stock market) and if the interest is too low, the plan will not work. Also, if you use a high yield checking account, you have to do a lot of tasks to get your high interest – like sign up for direct deposit, and make a certain number of debit card transactions each month. Miss one of these, and you lose the high interest.
Probably one of the greatest risks of utilizing a credit card arbitrage plan is the potential damage to your credit score. Since you will be using the entire balance of your credit line, your score is almost certain to go down in the beginning. Missing a payment or making a late payment can cause even further damage to your credit rating and, under certain circumstances, may increase the interest rates of your other loans.
Should You Do Credit Card Arbitrage?
Due to their volatile and risky nature, credit card arbitrage plans are only recommended for consumers that are well disciplined in managing their finances and bring home a relatively high income. A lower income means a lower balance, which is not likely to result in a profit that is worth the effort. Extreme financial discipline is required since the interest rates must be monitored extremely carefully and the monthly payments must be made even in the event of an emergency.
If you plan to utilize a credit card arbitrage plan, there are a few essential steps to take. First, you must determine the ratio between the credit card interest rate and the savings account’s rate. You must also carefully read all paperwork to ensure that no fees will be charged. Once you have transferred the money from the credit card loan, it’s a good idea to set up an automatic payment method. Most credit card companies offer this and it will ensure that each payment is made on time. If you successfully pay off the card in time to earn a profit, you should keep the money in the bank for as long as possible so that it will continue to gain interest.
Readers, what are your thoughts on credit card arbitrage?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him here.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.