Credit Card Balance Transfer

Credit card arbitrage by balance transfer

Credit cards often get a bad rep, especially among younger generations. It’s true that credit cards come with drawbacks, though if credit cards are used in a careful way – including repaying the balance in full before any undue charges or interest take effect – then the advantages can soon pile up.

Used wisely, a credit card balance transfer might be one way to either:

• Repay accumulated credit card debt and exit the debt trap, especially for those who might be struggling financially, or
• To access cheap credit, for the financially sophisticated!

Read on to learn more.

What Is a Credit Card Balance Transfer?

Balance transfer credit cards offer a zero percent, or very low, annual interest rate on transferred balances for a limited time, providing temporary relief from high-interest debt. This can provide a temporary reprieve from high interest rates and is an opportunity to repay the debt.

How Do Balance Transfers Work?

A balance transfer happens when you receive a new credit card which takes the balance from an existing card. In the process, you owe the new credit card provider the money, and the existing card is repaid. The new credit card will have a low interest rate, often zero percent for a set period. Occasionally you may be charged a one-off “transfer fee” of around one or two percent, plus any other routine annual charges for the new card.

Accessing the lower interest rate card lets you pay the debt off faster as you’re not paying interest on top or are paying a much lower rate of interest. Balance transfer credit cards can be a fast way to clear debts, and for those who are financially sophisticated may be a way to access low-or-no interest funding (more on that later).

Why Do the Banks Offer Balance Transfers?

Banks are smart. And very profitable.

It would be great to think banks offer balance transfers out of the good of their hearts to help people get out of financial strife, but banks probably use credit card balance transfers to lure new customers who have a habit of being in debt (after all, banks may as well be called “debt shops” who just want to sell more debt!). The catch being that if you fail to repay the entire balance within the low-or-no-interest period, you'll be hit with a staggering interest rate, perhaps as much as 30 percent annually. If it comes to that, the result is a high monthly interest bill and your debt inflating.

The banks are betting anyone who transfers a balance will probably get into the habit of using this new bank, and the new credit card too, so they’ve just secured a new customer.

Without a commitment to ongoing repayments to clear the balance (in other words “an exit strategy”), you might get stuck in expensive debt that is hard to escape. For many people, a credit card balance transfer could spell continued trouble.

However, if you meet certain criteria a credit card balance transfer could be a great way for you to access additional leverage and put those funds to good use. This is advanced thinking that’s not for everyone, so bear with us while we explain…

Credit Card Arbitrage

Credit card arbitrage refers to the process of borrowing money from a credit card at a low interest rate and then investing that money at a higher interest rate to try to make a profit. The lowest risk and most common type of credit card arbitrage entails taking advantage of a credit card balance transfer with a low-or-zero percent interest rate balance transfer offer to borrow thousands of dollars from a credit card for the duration of the transfer period, which can be up to 24 months.

The borrower then places this money in a higher interest but low-risk vehicle, like a savings account or term deposit, where the interest rate received is higher than the interest rate paid.

Credit card arbitrage has a higher likelihood of being successful if a borrower makes all the required minimum monthly payments on the credit card on time and repays the balance in full before the introductory period expires. Even then, though, the amount of money one might earn from this strategy may not be worth the risk.

Who Suits Credit Card Arbitrage?

Selected individuals and households may benefit from this sort of approach, especially if they meet all the following criteria:

• Willing to pay close attention to the term limit and fine print associated with this sort of tactic.
• Financially disciplined.
• Have good cashflow, and stable income. Preferably have reasonable expectations of growing income, or at least be largely in the driver’s seat with their own income: perhaps working in sales, be self-employed, or receive some variety of performance-based remuneration.
• Are already financially savvy, including having downside protection in place in the form of appropriate insurance and contingency funding set aside and readily available.

Potential Downsides of Credit Card Arbitrage

Borrowers often make less than they expect when attempting credit card arbitrage. Suppose you borrow $20,000 from your credit card at zero percent and invest it in a 12-month term deposit that pays five percent interest. You would've earned about $1,000 in interest income at the end of the 12-month term. However, your $1,000 will be taxed as income at your marginal tax rate, which could be as high as 39 percent.

So, for an investor in the 39 percent marginal tax bracket with $1,000 in term deposit interest income will pay $390 of tax, leaving $610 in net (after tax) gains. In other words, expect to lose a third or more of your credit card arbitrage earnings to taxes.

Additionally, if for some reason you must withdraw your term deposit before maturity, you’ll have to pay a withdrawal penalty.

Credit Card Downsides

Anyone exploring credit card arbitrage will still need to factor-in the universal downsides of credit cards:

• Credit cards require self-discipline. If you’re not disciplined, then credit cards are not for you at all. Don’t even consider credit card arbitrage!
• Credit card interest rates are high and can quickly compound and get out of control if you don’t make the repayments within any interest-free or teaser periods.
• Fees, transaction charges, and foreign exchange charges can all add up.
• The combined total available limit on all your credit cards is considered debt by lenders. So, if you’re applying for a home loan from a bank and you have two credit cards, each with a limit of $10,000, the bank will consider that you’re already $20,000 in debt, even if you currently owe nothing on the cards. Lenders do this as you can use that line of credit immediately if you choose to, so the bank needs to reduce the total amount you can borrow for a mortgage accordingly.

Similar Takes to Credit Card Arbitrage

If you’re financially savvy, then you could even make use of a low or zero rate balance transfer for non-investment purposes. For instance, if you need to upgrade your car, perhaps to safely transport a growing family, you could use a balance transfer to fund the purchase. In this way, you could access an interest free loan of sorts! For the financially sophisticated, this might be a wiser option than any alternative source of funding, such as:

• Saving up a lump sum of cash.
• Getting a bigger mortgage.
• Obtaining a car loan with interest rates typically well over 10 percent each year.
• Making a withdrawal from an investment, such as selling shares or withdrawing from a managed fund.

It should be noted, this approach is financially unorthodox for good reason – most people aren’t careful enough to achieve this successfully. But, if you are, this could be a great way to access an interest-free line of credit.

Tips for Credit Card Balance Transfers

Pick a card with a small transfer fee and a long low-interest rate period, this should maximise the savings available.

If you’re lacking discipline, once the old card is free of debt, consider lowering the credit limit so you can still use it but only for emergencies. It is pointless to transfer a balance only to build up new credit card debt afterwards!

Prioritise Repaying the Debt (Unless You Have More Expensive Debts Somewhere Else)

Interest-free debt is rare these days, so you have the perfect conditions for repaying it.

Calculate what you need to repay per month by taking the debt amount and divide it by the number of low-or-no interest months you have available to repay it. For example,

If the debt is $20,000 and you have 24 months interest free, divide $20,000 by 24, which is about $833. This is your minimum regular repayment, though if you can, repay as much as is reasonably possible.

Savvy readers might realise that if they have a mortgage on their own home or other higher interest rate debt, they might be better making repayments to repay that debt instead. So long as there’s a lump sum available at the end of the low-or-no interest period on the balance transfer credit card, that choice could make financial sense.

Read the Fine Print

Depending on your provider, there could be any number of hidden fishhooks with a balance transfer, for instance:

• Your transfer may be low interest, but like any credit card, you’ll need to make the minimum payments. If you don’t, you’ll usually be charged penalties.
• In most cases the balance transfer interest rate only applies to the balance you’re transferring. Typically, for all other purchases or cash advances, the standard interest rates for that card applies. That is, if you spend anything on your new credit card, you’ll still be hit with top tier credit card interest rates.
• Banks are picky about who they give balance transfer credit cards to, as, after all, a credit card is just an unsecured debt. That means there’s no guarantee you’ll be accepted for a balance transfer, should you apply for one. If you have a bad credit score, getting a balance transfer may be more difficult.
• You can't apply for a balance transfer credit card if you are a customer of the bank offering a deal. For example, if you have an ANZ credit card, you will need to apply with other banks such as ASB.

Only making minimum repayments, usually anywhere from 2% to 5% of the balance, is unlikely to make much of a dent in the debt. You should plan to pay more than the minimum unless you have more expensive debt to pay.

Consider Another Transfer

If you still have a balance owing after the low-interest period, apply for another balance transfer credit card

Don't be afraid to transfer to another bank to save on interest costs. ​If you don’t, the remaining balance will be hit with whopper annual interest charges, unless you accessed a rare 'life of balance' deal.​

The Bottom Line: Credit Card Balance Transfer

Credit cards require self-discipline. If you’re not disciplined, then credit cards are not for you!

If used intelligently, with discipline, credit card balance transfers can save thousands of dollars in fees and interest, and in some selected instances you might even be able access a line of credit with a near-zero interest rate. Beware though, credit card arbitrage is not for the faint hearted!