Credit card arbitrage
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 do you do it?
The beauty of this arbitrage is the simplicity.
Apply for the credit card offering the 0% balance transfer/cash advance.
Once approved, write a credit card cheque to yourself and deposit it into a high interest rate savings account or a GIC.
Before the balance transfer offer expires (usually 1 year or more), pay back the credit card in full.
Note, NEVER make any purchases with the credit card as they will charge you with regular interest.
This process will enable borrow money at 0% and keep all the interest that it generates.
Options on what to do with the money
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. Placing the money into the stock market for 1 year is too risky for my blood.
Here are some options:
Place it in a high interest savings account, like PC Financial (4%) or ICICI (4.5%).
If the time line is long enough, you can place the funds into a 1 year GIC (4.5% @ PCF, 4.65% @ ICICI).
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.
Implications
For those of you who don’t know already, 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.
http://www.mydollarplan.com/