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Credit Card Arbitrage I – How Does it Work?





This is an article I first wrote back in 2007, but reposted due to changes in the financial landscape.  You can now use this strategy with the TFSA to avoid paying any tax on the interest earned.

Credit card arbitrage seems to be a popular strategy to make a few bucks in the personal finance blog world.  I’ve personally never done it myself, but the concept is simple enough for me to explain it and give my opinion on whether it’s worth the fuss.

What is Credit Card Arbitrage?

Credit card arbitrage is where you take a low rate balance transfer promo offer from a credit card company and invest it in something that will hopefully give you a higher return.

How Does it Work?

The beauty of this arbitrage is the simplicity.

  1. Apply for the credit card offering the 0% balance transfer/cash advance. (Update: July 2013 – MBNA is offering 0% for 12 months with no annual fee)
  2. Once approved, write a credit card cheque to yourself and deposit it into a TFSA high interest rate savings account or GIC.
  3. Before the balance transfer offer expires, pay back the credit card in full.
  4. Note, NEVER make any purchases with the credit card as they will charge you with regular interest.

Strategies

In order for it to be called arbitrage, you need to make a profit from the deal.  However, in my opinion, guaranteed profit is the recommended route to take.

Here are some options:

  1. Place the cash in a TFSA, either a highest interest rate account or GIC.  Note the TFSA contribution rules when repaying the credit card.
  2. Place it in a taxable high interest savings account or GIC.
  3. You could use the money as an interest free RRSP loan.  The only issue being that you will have to make up the difference between what you owe and what you get on your tax return.  Even so, your tax return will probably not get to you in time to pay back the balance, so you would have to ensure you have cash on hand to pay back the loan in full.
  4. If you have a used car purchase coming up, and plan to get short term financing (1 yr or less), then using a 0% card may make sense.
  5. Although the stock market may be an option, placing the money into the stock market for 1 year is far too risky as capital preservation is high priority in this strategy.

Note: As of August 2011, check out the smaller online banks like Outlook Financial or Achieva for the best TFSA rates.  For more ideas, check out my high interest rate TFSA article.

Implications

  • If the money is placed in a taxable account, interest income is taxed 100% at your marginal rate.  For more info read my article about how Canadian investment taxation works.  So if your marginal rate is 40%, then 40% of your interest income/profit will be taken by the government at the end of the tax year.
  • The second biggest drawback of this strategy is the potential draw down of your credit score.  If you borrow the maximum balance on your credit card and keep the balance for a period of time, your credit score can be affected.  The solution?  Only borrow half of your credit limit.
  • If you withdraw from a TFSA to pay back the card, you cannot recontribute the same amount until the new Calendar year.

What’s the next step?  Check out  Credit Card Arbitrage II – An Analysis, I will get into the offers available to Canadians, some number crunching and final conclusions.  Stay tuned!

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52 Comments, Comment or Ping

  1. I heard a lot about CC arbitrage but never tried it myself. When you write a cheque from a credit card, it is from an existing credit card that you have right? Then, you transfer this balance onto a 0% transfer new credit card right?

    Therefore, your first credit card will drop down to 0 again. So this technique should not affect your credit score that much then. Mainly because Are you going toeven if you take the full amount of your credit card, you will still show 50% debt-to-available-credit ratio for the two cards. If you don’t have much on your other credit accounts, your ratio will be less and won’t affect your credit score at all.

    All of a sudden, this sounds very appealing. I guess that making an extra few bucks would be great. I am looking forward to the part II of this post ;-D

  2. Hey FB, The concept is that you’ll have to sign up for a new credit card that offers 0% balance/transfer cash advance. Once you receive the new card and cheques, you write yourself a cheque and deposit it in your “savings” account to collect the interest.

    Stay tuned for tomorrows post!

  3. Hi FT, how does writing cheques to yourself from a new card constitute a transfer? I always thought that 0% transfer offer were to transfer existing balance on your already existing credit cards?

    So basically, you are saying that I can apply for a 10K new CC with a 0% transfer for a year let’s say. Once I receive my card, I write a CC cheque to myself in the amount I want and I can invest that money for free for a year?

  4. Hey FB! You got it! Write a cheque to yourself and invest the money. Typically, you can use credit card cheques to pay off other balances, which would be a balance transfer.

  5. 5. DtotheC

    It would be interesting to hear from someone who has done this in Canada. Jonathon at MyMoneyBlog has written extensively on this subject, but I haven’t come across anyone in Canada who has yet.

    I wanted to try it myself, however, I’m a student at the moment and the banks won’t extend me enough credit or a decent enough credit card to make it worthwhile.

    Two things i’d like to know about:
    1) if i understand 0% balance tranfers correctly, you still have to make payments every month on the balance owing. This would be taken from the money you invested. (Easy if in a high interest savings account, but maybe a problem if in a GIC?)
    2) how to actually transfer the balance onto your new credit card. Jonathon mentioned that he usually does it on the phone while setting up the new card. I’m wary about writing a check to myself since it might be construed as a cash advance rather than a balance transfer. The difference being, interest is charged on a cash advance from the moment it goes through. This would be bad.

    Can anyone clarify it for me?

  6. Tomorrows post will focus only the technicalities.

    1. With the offer that I will post about tomorrow, you will have to make $10 payments every month. In my opinion, keep the money in the GIC and pay the fee “out of pocket”.

    2. With this arbitrage, the point is to get cash into an interest bearing investment. I’m not sure how to get the cash into a savings account without writing a cheque. In this scenario, yes, writing a cheque would be a cash advance, but it will be @ 0%. However, here is at least a 1% fee on cash advances (MBNA), which I will talk about in detail tomorrow.

  7. That’s great, I didn’t think CC companies would let you write cheque to pay your other credit card and that in fact, you could simply withdraw the new money and invest it.

    I would expect CC companies with 0% trsf to control the transfer actually!

  8. Then, instead of writing a cheque from the new CC, how about withdrawing money from an existing credit card and than transfer the balance to a new 0% trsf CC? You will not have to pay fees and you will get to the same result right? On top of that, you won’t hurt your credit score that much…

  9. I think you may be right FB, perhaps CC companies would have issues with payment from another CC. I’m not too clear on this issue. But for the purposes of investment, cash advances are what’s needed.

    If you withdrew money from an existing credit card, that would be considered a cash advance and will face a cash advance “fee”. Typically 1%.

  10. 10. Pauls

    Another angle:

    Is it possible to be able to string together no interest offers so that one can pay off another. By “string together” I guess I mean to take out multiple offers from multiple cards, and use the cash to pay off the other card when it comes due.

    Also, I know FT doesn’t like this, but investing in a dividend ETF might be a fairly safe way to get some potential capital appreciation upside.

  11. 11. Nars

    Do you know any Canadian CC companies which give 0% APR for a year?

    Thanks

  12. Pauls, the only issue is that 0% APR CC’s in Canada are fairly rare, however, there are a couple available. Yea, i’m not a big fan of using money for 1 year to invest. What if it came time to pay back your balance, and the market tanked like it did in July/August past? You would end up having to pay the difference out of pocket.

    Nars, tomorrows post will outline a couple of 0% apr credit cards available to Canadians.

  13. 13. nobleea

    I realize it’s pretty much guaranteed money, but is it really worth it? i mean, if you to take a 10K balance, then you’re looking at around $450 in interest. Minus the income tax you’ll have to pay on it at say, 36% marginal rate. Now you’re down to $290. Plus the intangibles of having this on your credit score (it stays on the record for 7 years, even if its paid off?). Does the credit score not go down if you get in to a habit of applying for credit often? And then having to make minimum payments every month. Works out to about $20-25 a month.

    If you expect the US$ to go down further (I do, over time), then you could open an american savings account (which pay more in interest) and then get some capital gain from the currency drop. Of course, you’d have to be careful how to do the forex as this could destroy all your earnings. Earnings are not guaranteed then.

  14. 14. Rod Payne

    I’m doing this (in Canada). I’ll wait until tomorrow’s post to relate my experiences.

  15. 15. Bean Counter

    I’ve done this several times in Canada. Basically you need to look for new credit card for 0% transfer. I’ve made several thousand (in total) of interest income from these deals. However, one thing you need to take into account is the hit on your credit scores when you apply for new credit card. I’ve heard that new credit card (less than 12 months) would hurt your credit score. Also each credit check would hit 3 points from your existing score. Therefore, it may affect you if you plan to apply credit within a year.

  16. Bean, your credit score will not necessarily drop that much. In fact, a hard hit (such as a credit card request) will hurt your credit score by 1 to 5 points depending on how many demands you make and what are your existing credit behaviors.

    If you have a strong credit score (over 700), it’s not 5 points that will hurt you. However, if you don’t have much credit accounts (like 3 credit cards and a student loan for example), you might hurt your balance-to-available-credit ratio. This will affect your credit score by more than only 5 points (it can be more than 20 actually).

  17. 17. Jerry Hung

    There are 2 threads on this in RedFlagDeals
    One from Citi 0%, one from MBNA I believe

    I thought about them, but then decided not to bother. There are other ways to make money
    - don’t want to hit my credit score too hard (which I’m sure I’m fine)
    - have to remember to cancel before 1 year
    - not really that much profit, after tax. Of course it depends on your limit as well

    Maybe tomorrow’s article will change my mind, you never know :)

  18. 18. Bean Counter

    FB – totally agree with your chain of thought. I do maintain a healthy credit score (around 780) and that’s why I’m confident using the 0% balance transfer to make passive income would not materially affect my credit score. I was just tring to remind people with plans to do financing in near future should take their credit score into considersation when applying credit cards and doing 0% balance transfer. Personally, I’d tried utilizing all possible avenues to make as much as I can.

  19. Well I think credit cards helps us to score a good credit as we get higher return when we go for the credit card arbitrage. Like his we can make and save money.

  20. 23. oOKitijimaOo

    I have invested $10,000 of the credit card cash advance into various mutual funds. I will let you know how I do within the 15 month time frame.

  21. If one does the credit card arbitrage but cancels the card after a year, do you know if there’s a hit on one’s credit?

  22. cad$, i’m going to drum up a post about your question, stay tuned.

  23. 29. Damir

    I was on a “Credit Card Arbitrage” throughout 2007. The credit card was charging 1% interest. I parked the money in a 4% saving account.
    Is the interest I paid qualified as an investment loan for tax deduction?
    Would it qualify if I used GIC instead(as it stands for Guaranteed INVESTMENT)?

  24. 30. nobleea

    Damir;

    Yes, the 1% interest is tax deductible. But you must also pay taxes on the 4% you earned in the savings account.

  25. 32. Sean

    This article should be titled, how to serve yourself up as a hot lunch for the banks.

  26. 33. JR

    Sean, I call this a chapter of using OPM’s the Canuck way.

    Timing is everything, as is the no fee & no carrying charges Arbitrage.

    I’ve used it, but unlike Frugal mentioned on writing a cheque to yourself it is generally considered a cash advance … & does not always work that way, for free anyway.

    One option I used was to go out with CC 1 and purchase something big. I did this at $13k, I went to the Sony store and bought $13k of the most expensive home entertainment equipment there is.

    Having the pre approved MNBA zero 12 months interest card ready to go, when the bill came in on CC1, I did the balance zero interest, no-fee transfer to CC2 12-months.

    Within 2-weeks of all of this I returned the purchased items to the Sony store (policy return for full refund) and they weren’t too pleased, however, CC 1 had a credit of 12K. I called CC1 company and said “close my account” and send me the money.

    Now $13k in hand for one year, what do I do?

    Timing is everything … and I did this twice

    Example one: December time frame, maxing on RRSP’s (since I hate these, unless I can profit from the exercise)I slapped $10k into an RRSP daily interest account with TD.

    Early January I took $10k out in $5k lots, (minus the 10% witholding tax)giving me $9k, not forgetting I have $1k of tax credits, but will have to deal with reporting the $10k RRSP withdrawal next year.

    With that $9k + $1K from the $3k left from the CC1 closedown, this time I slapped $10k back into the RRSP again, putting this time into the Questrade RRSP (fee free) trading account. What I used the $10k for to get more OPM’s and further tax savings/refunds, I shall tell you later.

    Now I have a $20k RRSP deduction, which in my case provided a refund of $8k in early April… always efile

    I still have $2k of cash from the CC1 return, $8k from a tax refund, totals $10k … What should do with that $10k before year end, should I stick it in mut-funds, do the SM manouvre, pay down the mortgage and increase the HELOC …

    Since I dislike paying taxes, dislike paying others to manage my money from the likes of financial institutions, stock brokers, FA’s and the Mutfund companies, all IMO since I’m frugal, take their service charges, broker fees and MER’s on my behalf and all of whom are not responsible for the downside of my portfolio. There are no guarantees I’m told by all of these people.

    My initial financial goal (since I work for an employer)was to see if I could get all of the income tax money back that was taken from my wages at source and get this back using the Aribitrage method (starting out with zero & using OPM)then working my way up to building equity and hopefully getting a low interest lown that is even more leverageable.

    This one method allowed me to build my own version of frugal’s million dollar journey, adapting and already using many of the articles discussed in Frugals web-blog

    TBC

  27. 34. misanthropope

    yeah, screw around with credit cards. you might make five or ten dollars, and what’s the _worst_ that can happen, right?

  28. 35. Sean

    I am not going to explain all of the permutations or ways that this strategy could lead to serious financial losses. I will simply state that investment with borrowed money is not zero risk. And Arbitrage is only arbitrage if the risk is zero.

    Without being specific, I would caution anyone who cares about his financial well being to use extreme caution employing any of the strategies used on this page.

  29. Solid article from 2007. Here’s an updated article that adds value and complements this article: http://colourfulmoney.com/credit-cards/credit-card-arbitrage/using-credit-card-arbitrage-to-earn-money/

  30. 39. cannon_fodder

    FT

    I received a new 0% credit card from MBNA and closed out my old one. This time I have 15 months to pay it back and the limit went from $20k to $30k. Most of the money will go to TFSAs and RRSP contributions.

  31. 40. Jaffery

    I’ve read a lot of about credit card arbitrage, but it’s something I’m a little too confuse to consider trying. I would, however, love to hear anyone’s opinions or experiences about it! Has anyone really made it work well for them without any major losses?

  32. 41. Linda

    I have 2 MBNA cc’s – long story, no balances on either. And they both sent me offers earlier this year for 0% financing over 13 months. I seriously considered putting it in to a conservative TFSA mutual fund investment but in the end decided against it. I called them to confirm the process for doing this that would fall within their requirements and the CS Rep told me to write a cheque to myself, deposit it in my chequing account and then invest from my chequing acct. They didn’t want me to write the cheque to the investment co. directly. The other key thing is that even at 0% interest, you still need to pay a minimum monthly payment of I believe it was 2%. It just goes directly to principal. If you have the room in a TFSA, that would be the way to avoid paying tax on your interest income.

  33. Great article! Have you tried credit card arbitrage using a Tax-Free Savings Account (TFSA)? It’s a great opportunity to earn investment income tax-free, and contrary to the name, you can chose investment options other than savings accounts.

    In 2007, as you’ve said “…interest income is taxed 100% at your marginal rate.” As of Jan 1, 2009, you could save yourself the tax by putting up to $5000 annually into a TFSA, where investment income earned is tax-free. For those who haven’t contributed to the annual max of $5000, the unused contribution room is carried forward and accumulates in future years. Combining the power of a TFSA with credit card arbitrage could be a great opportunity for those who do so wisely!

  34. Thanks for the ideas guys! The savings landscape has certainly changed with the invention of the TFSA. Now, if interest rates would go up a bit, CC arbitrage could be a real money maker with very little risk.

  35. Great post!

    I’ve had 3 MBNA card and used them to my advantage on a few occasions, but have since closed them down. Used properly, they’re great!

    I don’t want to sound like a party pooper, but you may have heard the recent news of TD buying Bank of America’s Canadian credit card assets right? Well that’s the MBNA cards.

    What’s worse, is that one of the TD executives were interviewed on BNN the other day, and he basically said that they will be “rolling out” these promotional cards over the course of the next 12 to 16 months.

    So take advantage of these promotions while you still can!

    Just when you think there’s a nice, low-interest introductory rate product for Canadians to take advantage of, we see it being taken away in exchange for a more conservative credit card arrangement for customers. I suppose we can’t expect anything less given Canada’s financial institutions having more conservative approach to things.

    I used to really enjoy reading some of the credit card arbitrage stories at My Dollar Plan’s blog, even though they were tailored mainly to American consumers. If Canadians had half of the credit card promotions that our friends south of the border were able to avail of, some of us, like Frugal Trader would certainly be reaping the benefits!

    Nice post! BTW – I’m officially tied as your top commentator. Next week’s roundup? :)

  36. 45. Guest

    @Frugal Trader Have you done this with the MBNA card? May I ask how much you borrowed and what rate you received for your TFSA? How much income was generated?

  37. @Guest, I haven’t as my TFSA is already maxed out. The returns are also quite low right now due to low interest rates. You can see my analysis here:

    Credit Card Arbitrage II – An Analysis

  38. 47. SST

    I have had a MBNA Platinum card for a couple years now.
    I have maxed out the credit limit using their 0% rates on two separate occasions in a semi-arbitrage manner.
    I bought silver bullion @$20 and $31, and sold both positions at @$48.

    The first 0% offer was 12 months, the second was for 14 months.
    (The offers being sent to me currently are now up to 3%!)

    My total “arbitrage” return is 97% — tax-free.

    Keep things SIMPLE!

  39. 48. Jungle

    We just got our third 0% credit card for 15 months. We put the whole thing on the mortgage with a 5.14 interest rate, then reborrowed on the heloc to buy stocks paying dividends around 5%.

  40. 49. SST

    @Jungle: are you going to be paying tax on those dividends?

    MY way of thinking around these 0% CC’s is to “arbitrage” inflation instead of trying to eke out a one-digit return in a dicey stock market. REAL inflation is well above 10%, so I buy goods/hard assets which will cost after the 12-15 month period of the offer expires.

    But each to their own.

  41. 50. Alain Chiasson

    I got the 10 month offer from MBNA – balance transfers. There is a fee of 1% to do the balance transfer, which needs to be taken into consideration.

  42. 51. Chain Chinapen

    can you do this in the USA?

  43. @Chain, I believe credit card arbitrage started in the US! So yes, i believe you can do this in the US.

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