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Say No To Credit Card 0% Balance Transfer Arbitrage

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This is a Devil's Advocate post.

I usually save Devil’s Advocate posts for more big time personal finance advice but with the recent spat of 0% balance arbitrage posts (of which I’ve wrote several), I felt that I should write a post arguing the potentials risks of 0% balance transfer arbitraging because you don’t see many of these out there. For those who aren’t familiar with the practice, basically you apply for a bunch of credit cards with 0% balance transfer offers, request a balance transfer check, and deposit it in a high yield savings account – pocketing the interest.

Here are some reasons why you shouldn’t do 0% balance transfers:

Universal Default = Death

Universal default is the keywords you should look for in your credit card agreement (don’t bother looking, I guarantee its in there) and what it means is that if you miss a payment, any payment on any account, you could see your 0% balance transfer offer interest rate spike up to rates as high as 30%. So if you miss a cell phone payment or a water bill payment or anything anywhere, you could see your 0% rate disappear.

Oh, and if your card does two cycle billing, you could get creamed the last two months as your 0% balance disappears but the “two cycle” math keeps it on the books. It’s a ridiculous thing but it does happen. No one has ever complained of this, I don’t have a card with two-cycle billing, so I’m not 100% sure this is true but it should be.

Your Credit Score Will Plummet

When you apply for credit cards, the bank will do a hard pull inquiry of your credit history to assess your credit worthiness. As you accumulate more and more of these inquiries, your credit score will fall lower and lower. As you request balance transfers from these new lines of credit, your credit utilization will increase tremendously and your credit score will fall lower and lower. Plus, when you pay off these debts, your credit score isn’t going to recover immediately – it takes a little while before you get back to normal. So, if you’re planning on any big purchases, this drop in your credit score will likely result in loans with a higher interest rate that will make your interest earnings look meaningless.

The Payoff Is Miniscule

Let’s say you get $10,000 in debt at 0%, you put it in a 5% high yield bank account, that means at the end of the year you’ll get about $500 for your trouble. Now, take out a fat chunk for taxes and you’re really talking about very very little (at 25%, you only keep $375, or $31.25 per month). Is that really worth all the trouble of setting up an automatic bill pay (or paying it manually) every month, double checking when the offer expires so you pay it off, and then sending a big payment?

Anyone else have any good reasons why you shouldn’t be doing 0% balance transfers just to make a few extra bucks?

{ 22 comments, please add your thoughts now! }

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22 Responses to “Say No To Credit Card 0% Balance Transfer Arbitrage”

  1. Dus10 says:

    There is this guy on the Fatwallet Finance forums that has taken arbitrage to the next level. Instead of placing it in a sage high-yield savings account, he has been investing in REITs and Canadian Royalty Trusts (Oil & Gas). The equities that he picked all had very high yield dividends, and he was also loaning his shares out (I guess you can loan shares to people for the votes and they pay you, but you still own it, and you still get the dividends) and putting some options out there. With all of this, he has been getting a 56%, not including unrealized gains or losses. He has over $200K borrowed from 0% and low rate cards, as well as a HELOC and a stock-secured loan. Things were looking pretty good for him for quite some time. He was getting several thousand dollars per month from these and paying down the debt. He even managed to max out his 401(k), because he had enough money to live on from this.

    In November, the Canadian Royalty Trusts took a big hit due to new legislation from the Canadian Parliament that basically places an end to their untaxed status (they operate similarly to REITs). They all dropped between 20-30%. He kept his positions going, though, because he was still ahead; the CanRoys are still paying these nice dividends, but it is at a little lower rate.

    Yesterday, he took a MAJOR hit. 50% of all of his holdings were in NFI (Novastar), and they tanked! They are so long gone that they are actually not expecting any taxable income through 2011, and they are considering dropping their REIT status, as a results… no more dividends within a year.

    I feel really bad for the guy, because he had a great strategy, but he thought it was so water-tight that he could ignore some of the basics… like diversification.

    He is stuck with his positions on NFI, because they were bought with the stock-secured loan, and once he sells, he has to pay the loan off in full. Since he is upside down on it, at the moment, he has to wait it out for a while and hope it doesn’t drop more.

    I would say that this strategy could be sound, but he really needs to work on diversifying. First, he needs to look at sector diversity. This lesson was learned when the CanRoys slipped. So, he needs to find a few sectors that have good dividend yields. Then, he can split his portfolio among those sectors. Maybe it is 33/33/33 or 25/25/25/25. In addition to the REITs and CanRoys, there are the AmRoys (American Royalty Trusts) and maybe selected financial services equities. Then, within each sector, he can hold positions in five to eight stocks.

    If he would have followed that strategy, e only amounted to about 6.6% of his portfolio, max. With their huge drop, he would have only been down about 3%, instead of 22%.

    Maybe the entire lesson is to not head down the arbitrage road, at all. This guy is going to be eating tuna and crackers for a while, and he isn’t going to be making these serious contributions to his 401(k) until he is out of the mess.

  2. El Indio says:

    I would say another good reason would be that you’re wasting the 0% offers on other potential savings. For example:

    If you currently carry balances on other cards or have any other type of debt that can be covered with the transfer amount should take priority.

    You could also make a lump sum payment against the capital on any outstanding debt and repay yourself diligently over the following twelve months. That should save a lot on interests!

  3. Jesse says:

    I think you outlined the downsides pretty well. I just started one last year and I must admit though that there is a level of satisfaction in sticking it the big companies. Also, I overestimated the hassle-factor. It’s not a hassle at all. And $32 per month pays for a heap-load of magazine subscriptions :)

    If you don’t have your ducks in a row with the basics though (budgeting, investing for retirement, full-funded emergency fund) you should probably be focused on those things first.

  4. Ben says:

    Dus10 -

    Isn’t that a big flashback to the Roaring Twenties? Everyone buying “well leveraged” equities, followed by a market crash/bank run?

    You’d think people would know better than to get into such risky positions…

  5. Jeremy says:

    I was thinking the same thing as Dus10 when I read your article – that guy on FW. That said, he wasn’t engaging in interest rate arbitrage, he was making highly leveraged investments in high-yield, high-risk stocks. Big difference.

  6. Chris Hynes says:

    Here’s an interesting reason: I just got an offer from Citi on my balance transfer cards — they’ll give me statement credit for 10% of payments over the minimum, up to $550… That’s a straight 10% gain (non taxed I believe as it’s a statement credit) over and above what I’ve gotten from savings accounts.

  7. Don’t forget the minimum payments; you may not be getting the interest rate on the full amount transferred for any but the first month if you have to put more than you are getting in interest back onto the card to avoid defaulting.

    I considered trying some arbitrage a while ago when the online savings rates were at 4%, but the payoff was not really worth the risk. I don’t have any trouble paying my debts on time or early, and I am reasonably sure I would be able to cover the hassle part of everything without any trouble, but I can think of better ways to get a few hundred dollars in a year.

  8. KMC says:

    My biggie is the third reason. You’re exposing yourself and doing no small bit of work for several hundred dollars per year. It just isn’t worth it for me personally.

    Besides, I suspect there’s no a bottomless pit of 0% offers from new companies. I haven’t done this arb but I have to expect if you use a CitiBank card for a year, they (at least that card) aren’t going to let you do it again.

  9. Wow $30+ a month I think you just finally sold me :-) What have I been waiting for? I think Blaine brought up good points about the fact that you still have to make the minimum payments each month so you don’t get the full interest amount

  10. CPA1298 says:

    I’ve done the 0% thing, and I have to say I wasn’t happy. I borrowed a total of about $30k, $14k of which went into Roth IRAs and $16k went into Emigrant. My situation was a little unusual, as I had a house sale coming up (I was planning on renting), and my wife was going to transition from being a pharmacy student to a pharmacist ($96k/yr). Obviously, I didn’t think liquidity was going to be a problem, and that I was sticking it to the banks.

    Well, after our move we found a house we really liked, in a perfect neighborhood for sale by owner, $13k less than appraised. So, we bought it with 20% down. There went most of the liquidity to pay off the cards; after buying furniture the rest was gone. So, for the last 6 months we’ve had our back to the wall getting these 0% cards off our back. I’m pretty decent with finance, and my wife is blissfully naive. We’ve been sinking a tremendous amount of monthly cash into paying these things off; we currently owe $11,500 to Chase.

    Oh, not least, my credit score dropped 100 points; 780 to 680. That was painful. As I mentioned before, we bought a house….I felt pretty stupid with the loan officer interrogating me about all the cards/balances on my report, and I’m mumbling some stupid crap about 0% and free money. She wasn’t impressed.

    I don’t think this is a Devil’s Advocate post; I think is it the truth.

    • Also Not Impressed says:

      Re: CPA1298

      You really didn’t “do the 0% thing,” what you really did was borrow $30K on a credit card to make a down payment on a house and put money in your IRA.

      Are you really surprised that didn’t work out well? You should feel lucky they let you have the mortgage, they should have denied you with that much pending debt.

  11. CPA, I think that the real trick with these arbitrage games is that you keep all of the funds liquid or at least available before the amount is due through certificates of deposit. I do not think that they are worth the risk to begin with (as stated above) but they are certainly not worth the risk if you increase that risk by not keeping that money available on short notice. The margins are small enough now that they’ll be eaten up and wasted as soon as you start paying interest.

    If you are near or past when the interest charges come, you should look into transferring those balances to a new 0% offer to give yourself another year or so to pay them off. Nickel has a list of 0% balance transfer offers available that he published this morning.

  12. GaryP says:

    Any money you get from 0% BT arbitrage must be put in a safe, high-yeild investment. If you use if to put a downpayment on a house, pay off a car, or buy furniture then you are not doing 0% BT arbitrage but instead are doing exactly what the credit card company hopes.

    I have considered paying off my car, but what will I do in 12 months when the money comes due? No, I would rather sleep at night and have my 0% money earning 5%.

    I just did my App-o-Rama. I applied for 24 credit cards. Before my App-o-Rama my FAKO credit scores from TrueCredit.com was:
    TU777 Ex762 Eq736
    After 26 hard inquiries hit, my credit scores are now:
    TU766 Ex742 Eq706
    I will discuss some of the details of the credit score hit on my next post in my blog.

    I am trying to figure out if this can be a business. Then any BT fees and the interest would be tax deductible on Schedule C. To that end I have opened up a seperate checking account at my credit union where I can keep track of expenses.

  13. Bruce Davis says:

    Few middle class people pay 25% of the income from Credit Card Conv Check (0% offers) in taxes. Have you heard of the personal exemption and deductions. I pay close to 10% of my income from these offers in taxes.

  14. GaryP says:

    Bruce, you are right. 25% bracket does not start until income of about $87k for a family of 4 using the standard deductions and exemptions. 15% would start at $40k, and 10% at $25k.

    So right now I am only in the 15% bracket for any additional income I bring in from 0%BT but I would still like to keep that in my pocket and not send it to Uncle Sam. And I am also doing everything I can to get my income up to that 25% bracket yet find deductions to only have to pay 15% :)

  15. NR says:

    While I understand the concerns raised by others, I found this to be a very profitable exercise. During the spring of 2006, I applied for 10 zero percent balance transfer cards using both mine and my wife as separate applicants. I then borrowed the maximum allowed on each card using each card’s balance transfer option. In total, I borrowed roughly $140k. I incurred either a zero balance transfer fee or . I then put the borrowed money into UGMA accounts at an online bank, one account for each of my two teenagers.

    I am just now paying off each of the cards since the end of the 12 month window is closing. Even when paying the minimal balance transfer fees of no more than $29 or $75 (nothing in most cases), I earned a return of roughly 5% or over $7,000 over the year and the interest was taxable at my kid’s tax rate. The earned interest will remain in their account to assist in the purchase of their first car when they graduate from college in several years.

    Was the effort to initially set up all of this activity and pay 10 credit card bills worth it? Definitely!

    • Maria says:

      Hi!

      I’ve been reading for hours financial blogs and advice. Up until a few months ago, I was mostly financially illiterant. (So much so that when I got a credit card, I was simply ‘thrilled’ that the ‘store’ said the application was ‘approved’…not knowing that meant a 22% interest rate…and had I known, I’d not have paid any attention to that figure, hehehe.) I have only just begun to learn and I’m not even in my 20′s or 30′s! Your entry is exceptionally interesting. Do you have a financial blog?

  16. Anon says:

    For those living in high income tax states consider muni bond funds from the likes of Vanguard and Fidelity. For me in California, the Fidelity California Muni Bond Fund has a tax-equivalent yield of 6%.

  17. Kevin says:

    I did one of these 0% balance transfers with Discover and am feeling the pain. It was nice for a while – earning the 5.05 interest and all, but then my auto insurance policy came. It said I wasn’t getting the lowest rate possible because of my insurance score. (Oh no, not another score!). Well, Equifax provided this score to my insurance company and my rate went up. I am not sure what my score was before, but when I used 7500 of my 8000 credit line, my lowest credit score was 753. So, just think twice if you do one of these. As soon as I heard about the rate hike, I paid back the balance, but my credit score has not rebounded.

  18. Devil's Sidekick says:

    One more reason not to do it: Miss out on credit cards that feature rewards… 1% on anything and 2% additional on three categories is pretty decent. Sure, you have to wait until you reach 50 bucks. But if you spend 10,000 a year on a card, that’s at least $100 a year at least. (with a max on mine of $144/yr on the 2%) $244 is 2.44%. Not bad, especially these days of ultra-low interest.

    You never have to ‘fill’ your available credit, just pay at the end of the month. And there’s only one account to deal with. (And they don’t file it as income with the IRS)

    Added to the Credit ding, and so on… I find this sound advice.

    Out of curiosity… Is it repeatable? Do you still get 0% offers after you do this?

  19. AlwaysAThrill says:

    Man – people are just so stupid – what is so hard to figure out – I did this 8 years ago (just figured it out) – borrow money for free – invest in FDIC insured money market accounts and take the profit. Simple. Borrowed 200K = made 10K for the year – if you are going to do it do it big – have told many people but most are sheep who think”its too good to be true” but thank god for all the lemmings out there who spend the money – otherwise these offers would not exist.

  20. AlwaysAThrill says:

    it is pretty much a one time deal – harder and harder to find cards – even if you close account they just want to reopen old accounts in a year or so – can keep it going decent for about two years – so if you do it – do it big. One rule NEVER SPEND THE MONEY


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