Balance Transfer Arbitrage

With the recent Federal Reserve rate cuts, many online banks are sporting annual interest yields of 3.0% APY and below. With the rates as low as they are, are balance transfer arbitrage plays even worth it anymore?

The answer is yes, but with some caveats.

Scratch the Transfer Fees
When the rates were in the 5% range, a 3% transfer fee with a $50 or $75 cap was somewhat acceptable. If you could get a credit line of $5,000 then a max fee of $50 meant you were paying 1%. If you could earn 5%, that’s still $400 you were putting into your pocket (of which $100 would go to taxes later) for a little added effort. That same $5,000 with a $50 fee earning only 3% means that you only put $100 in your pocket of which $25 would go to taxes. $75 a year to make 12 bill payments a year? It’s not worth it to me and probably not worth it to you.

No Fee Transfers Okay
If you’re able to get a no fee balance transfer, a few still exist like the one from Citi Professional, then it’s still borderline. Is it worth it to carry $5,000 in credit card debt, make 12 bill payments, just to earn ~$112.50 after taxes? If you have zero chance of going after a loan in the next year and have plenty of time on your hands, it might be something you want to pursue. If you are, I suggest getting more than $5,000 because $112.50 is not a lot for your time and effort.

My Recommendation
The credit market is tightening, interest rates are falling, if you’re doing balance transfers to reduce the rates you’re paying for debt – get a 0% balance transfer. If you’re doing balance transfers for the added cash, hold off until rates get better (unless you can do better than a guaranteed 3%, say with a CD). Whatever you do, do not get a balance transfer and put it into something risky.

A cash advance is not the same thing as a balance transfer! In fact, they are worlds apart. A cash advance is used generally by folks in a bind or those who accidentally cash one of those “convenience” checks that the cards send out. A cash advance typically has high fees and a high interest rate, the two biggest killers of a balance transfer arbitrage deal. A balance transfer, if you pick the right card, generally will have no fee and 0% APY interest – which make it at all a consideration for an arbitrage play.

When you make your request, be explicit in explaining that you want a “balance transfer” and not a “cash advance.” Credit card companies rarely make this mistake, giving you one when you expected the other, but people make mistakes and you don’t want to be the one paying if a CSR keys in a request incorrectly.

theficus at Fatwallet Finance Forums reported that Bank of America flagged his account after a recent App-O-Rama (AOR). In his AOR, he deposited quite a large sum of money which BOA decided looked fraudulent. The post is very enlightening and should be a warning to balance transfer arbitragers that your bank may not look kindly to your large deposits. Now, theficus, who I think did absolutely nothing wrong, also indicated that racial slurs were used, which simply isn’t cool.

One of the more enlightening things about the post was that this had happened to other people with accounts at BoA (glockophile) and even at Citi (DjPiLL).

Check out the post, it’s very enlightening.

Universal default is a term that only recently came into vogue and it’s a big “gotcha” for balance transfer arbitragers because of it’s far reaching effect. If your card has a universal default clause, it means that if you are late on any of your payments to any other creditor and it is reported, they can immediately increase your interest rate without the typical grace period. Credit cards can already increase your rate arbitrarily but they have to warn you in advance and give you a period of time, 30 to 60 days, to react. With universal default, this can happen immediately (since it’s not a material change to your contract, it’s merely a clause that gets activated).

Universal default has to be a clause in your terms & conditions in order for this to apply and only a few card issuers have them as a standard. Recently (over the years I should say) there had been a lot of pressure for issuers to drop the practice and several of them agreed to.

• Discover, Chase, and American Express had UD clauses removed from T&C’s back in 2005 according to USA Today.
• Citi announced they’d be dropping UD, after making it optional (???), on 01 March 2007.

The idea of a balance transfer arbitrage seems like a win-win proposition right? You get a cheap, if not 0% interest, loan and then deposit it in a bank where you can earn more than 0%, sometimes much more (like over 4%). Borrow money low, lend money out high, and your borrower is 100% guaranteed by the FDIC. Are there any risks? The answer is Yes, but most of those are the borrowers fault, not the environment.

Risk 1: You Get Greedy
Sometimes 4% isn’t enough and people decide that they’ll put it in the stock market or into a mutual fund. Or they bet on something with the funds, just anything that isn’t 100% guaranteed like a savings account. This is the number one reason why the balance transfer arbitrage backfires and when it backfires in this way, it backfires supremely. When that promotional interest period ends, the interest that comes on afterwards is like a firestorm. Trying to pay back thousands of dollars with a double digit interest rate is really really hard and it’s made worse by the fact that you have nothing to show for it. This is the number one risk and if you are able to take the guaranteed winnings and go home, then balance transfer arbitrage is for you. If you can’t, do not do this play.

Risk 2: You Get Sloppy
If you miss a payment, expect your interest rate to go up to the regular double digit interest rate. If you forget when your promotional period ends, you’ll probably get dinged for a month’s interest before you scramble to pay it back. While neither one of those things is a major deal killer, they do cut into your earnings significantly. Miss the first payment? Consider yourself having just wasted your time and a perfectly good arbitrage opportunity. Miss the final payoff? You lose a little of your earned money, no biggie. These are not as bad as Risk 1.

Risk 3: Your Credit Score Is Important
If you’re going to make a major purchase on credit in the near future, I wouldn’t do the balance transfer arbitrage because you’ll be opening up a lot of new lines of credit, increasing the amount of credit you have, increasing the amount of debt you have, and increasing your credit utilization. All this will ultimately mean that your credit score will fall and it will fall a lot. Not to worry, when you pay everything back then your credit will be perfectly fine, if not better than before. However, in the interim you will take a hit in your score which will increase the cost of loans should you need them. My personal opinion, and you can take it for what its worth, is that if you need a loan within the next year, avoid balance transfer arbitrage because the increase in interest will make your earnings seem like a drop in the ocean.

There you have them, the three main risks of a balance transfer arbitrage play. There are certainly more but those are the big three you must be aware of before you undertake this endeavor.