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Understanding Credit Card Arbitrage

April 3rd, 2009

credit-card-arbitrage.jpgWith the current economic conditions, many people are looking for new ways to make a little extra cash. Credit card arbitrage is a process that allows consumers to generate profits with relatively little investment and minimal risk. This article by Rick Smith explains the definition and process of the credit card arbitrage opportunity, including the relevant advantages and disadvantages.

Credit card arbitrage is a technique that has been gaining popularity lately with the ever-worsening economy. Even though it is a very simple and straightforward process, there are a few pitfalls you should be aware of before taking the plunge. If you are a very disciplined person and are a bit of a risk taker, it may be right for you.

The word arbitrage is a French term that basically means referee or decision maker. In financial circles it is applied to any situation where you can make a profit by exploiting the difference between two market positions. For example, if you know someone is offering to buy an item for 10 dollars, and you have the ability to buy it from someone else for only 5 dollars, you can reap the profits. You simply buy as many of the relevant items as you can afford, hand them over to the person buying them at the higher price, and whistle all the way to the bank.

The big difference between arbitrage and a retail transaction is that with an arbitrage deal, you know exactly what your possible profit will be because the sale price is fixed before you execute the transaction. With retail you buy the goods for a fixed price, but then sell them for a variable price. Arbitrage is normally applied to investments of stock, bonds, and commodities but can be applied elsewhere in creative ways as well.

Credit card arbitrage allows the average consumer to take advantage of the difference in the cost of borrowing funds and the interest paid on investing them. This market difference has been made possible by the introductory offers that many credit card companies extend to consumers. Because of the rabid competition for customers, a lot of credit card companies will now offer certain cards with impressive limits at an introductory rate of 0% for a fixed period. This extension of “free” cash makes the credit card arbitrage process possible.

If a consumer accepts one (or several) of these offers and transfers the available funds from the credit card into a nice interest bearing account, they can pocket the difference. This is a perfect and practical application of the concept of arbitrage and actually involves no investment by the person reaping the windfall. However, there are a few things to remember when using this process, and understanding them will help you make the most out of this type of arbitrage.

All of the credit cards that extend credit at this introductory rate have penalties if you are late on a payment. These will include a late fee, and in most cases, the introductory rate will rise to a much higher interest rate on the outstanding balance. It’s interesting to note that a lot of the cards will transition to a reasonable rate naturally at the end of the introductory period, but if you miss a single payment during this period, the rates will be even higher. So be sure to make all of your payments on time to avoid this. Missing a single payment can wipe out whatever gains you may have accumulated. There are a lot of ways that you can set alarms each month to alert you to an approaching payment. It’s usually a good idea to send it in a little early to make sure it’s credited to the account before the due date.

You also need to understand very clearly when the maturity date for the card occurs. Many times the details of when the introductory rate ends are hard to glean from the account agreement and can be a little confusing. For example, if the agreement says that the introductory rate will expire in the last billing cycle before November 1, 2009 you might assume erroneously that you can pay the card off in November. The truth is that the rate would actually end with October’s billing and you should have settled out the balance then. If you have any questions about this date, be sure to call the customer service department for the credit card to verify things.

Another concern is that by taking on new cards, you will affect your credit score temporarily since you are adding to your potential credit balance and number of outstanding accounts. Also to make this process work for the highest return, you’ll need to invest as much as possible from each card. This will hurt your credit (or FICO) score even more since the outstanding balance on a card is a factor in determining your FICO score. Since you will be maintaining the high balance on the card for the duration of the introductory period, this effect may last for several months. The good news is that as soon as you approach the end of the introductory period and pay off the card, your credit scores will recover pretty quickly. The key here is to remember that you are actually “borrowing” the funds from the credit card and will satisfy the total balance prior to the end of the introductory period.

So considering all of the potential for a good return on your investment, credit card arbitrage is a fairly simple process to use. Like any investment, there are risks involved that you should be mindful of before investing. While this type of process may not be right for everyone, if you have sufficient fiscal discipline you can make a nice profit from credit card arbitrage with little risk or investment of your funds.

One Response to “Understanding Credit Card Arbitrage”

  1. comment number 1 by: Hank

    What an interesting idea. Worth looking into at least.

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