The Dangerous Allure, Risks & Perils of Credit Card Arbitrage

It's a card you get so you can navigate society.

POSTED BY ANNA GRAHAM

Comedian Adam Carolla had an interesting quote about credit cards. “You don't realize how much you use your credit card, not even to buy things. It's a card you get so you can navigate society.” 

Indeed, the psychology of credit card spending might well be linked to a person trying to cope with life, and not actually treating a credit card like what it is - a short-term loan. 

In a similar vein, credit card arbitrage could be either a shrewd way to deal with a unique financial situation - or it could be yet another impulsive and disastrous decision that leads to even greater debt - like credit card spending!. 

In this article, we’re going to discuss the risks of credit card arbitrage and whether it’s right for you. 

Understanding Arbitrage

Credit card arbitrage is when a person borrows credit card funds at a low-interest rate in order to invest the credit at a higher interest rate for a profit from the difference. 

For example, if a lender offered zero percent APR for a limited time, a person might transfer the old balance to a new account. If the new account had higher interest rates, that difference goes to your balance.

This idea is based on traditional arbitrage investment, where an investor buys and sells an asset in different markets, solely so they can take advantage of the vast price difference, thereby generating a profit. Price differences tend to fluctuate, making it a bit of a gamble, but still a way to make a return. 

Does that strategy work with credit cards? In theory, it could work, as long as you make minimum payments every month after transferring the money. 

The big issue is if you can pay off the balance before the lower APR rate expires, or withdraw the money and pay the balance owed using some of the interest you accumulated. 

The Advantages of Borrowing

The risk aside, as long as you can guarantee minimum payments and have a plan to pay off the balance before higher interest APR kicks in, you might be able to make a contract like this work. 

Some lenders offer multiple ways to generate a profit through interest. With perks like no annual fee, cash back, the ability to redeem points in cryptocurrency, and automatic reduction of APR after a certain date (such as offered by the SoFi online brokerage) you could still see a profit and get out of a bad contact with higher than average interest rates.

The Risks of Credit Card Arbitrage

One of the most common problems you see in finance is that people will try credit card arbitrage with a poor investment strategy. It’s becoming more difficult to find opportunities that will give you a higher rate of interest in the first place. 

What if the lender changes the terms before the payoff? If you ever default on the loan then not only do you incur a late fee, but you also risk the company changing the terms you both agreed on. If you default on the loan first, then you break the contract. They can now charge a higher interest rate, thereby getting rid of the initial profit you had.

What if you lose your job or another emergency happens? Unpredictable changes to your income, like missing work or a hospital stay, are what cause people to charge money they don’t have in the first place - and that traps people into perpetual debt. 

You could even damage your credit score by increasing utilization ratio, as well as a higher debt-to-income ratio. Be sure to check out what factors lower credit score before applying for a loan.

Pay Attention and Win

The first step out of a debt trap is to develop a strategy and find a lender that you can work with for the long-term future. Don’t mistake credit card arbitrage as a legit way to crawl out of debt. The best way to reclaim financial independence is to change the way you live, work, and save, as we wrote in a recent article.

In the meantime, read over every contract carefully, and pay special attention to monthly statements and online notices as well, since some companies will change the terms without much notice - and hope you don’t see it! 

But they always have to say it somewhere in writing, somewhere where you could see the change if you’re being vigilant. 

Pay attention to the finest print and you can find ways to maintain profit and avoid debt. 

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