IF you can borrow money at 0% interest rate and keep that money in a savings account, you will earn the interest on whatever amount you borrow.  Now, imagine that you can replicate this with dozens of accounts.  That idea (came to be known as App-O-Rama or Application-O-Rama reported on the Wall Street Journal) has been sweeping through internet finance discussion forums in recent years where people discussed strategies to getthe maximum number of 0 percent apr balance transfer credit cards and then capitalize on the interest-free loans.  Suze Orman is scheduled to air an episode of her show on August 4th titled “The App-O-Rama Drama.”  This has tremendous significance in finance and economics where it is known as Interest Rate Arbitrage or Interest Rate Parity

An arbitrage is a gap in prices that presents an opportunity for someone to buy and sell the product, without risk.  This allows someone, at least theoretically, to make a boat load of money.  Does this arbitrage condition really exist?  Exactly how much can someone make by doing an App-O-Rama?  Does it make economic sense for credit card companies to allow such promotion?  I will attempt to give thorough and objective answers to these questions.

In order to properly analyze this financial phenomenon, we assume the following:

  1. Only considering credit cards with very low and 0% apr.
  2. Applicant has immediate access to the loan upon approval.
  3. Transfers between banks and credit card companies are instant.
  4. Applicant will pay his/her bills on time.
  5. Interest rate for which the fund is earning will remain steady.

Simple Arbitrage Criteria

The best way to analyze the existence (or non-existence) of this is to study and measure the pay-in’s and pay-out’s from partaking on this venture.  They are defined as:

Pay-Out = (Loan Principle + Interest) + (Balance Transfer Fee) + (Tax on Interest)

Pay-In = (Deposit Principle + Interest)

We compare the amounts, including fees, in end-of-loan dollar term value.  The task now breaks down to comparing Pay-Out vs. Pay-In, and we can quantify the value of the arbitrage. 

There is an arbitrage opportunity when

Pay-In > Pay-Out.



Example 1: John Doe is approved for a 12 month 0% apr credit card with a $10,000 credit line, a balance transfer fee of 3% to a maximum of $75, and decides to put the $10,000 into his 5.05% APY savings account at HSBC.  Let John Doe be the average American within the 28% tax bracket.  Using the Pay-In and Pay-Out method outlined above, the Pay-Out comes out to $10,229 and the Pay-In comes out to $10,505.  So the net profit John Doe reaps is $275.

Example 2: Jane Doe is in an identical situation as John Doe except her apr is 2.9%.  The Pay-Out for Jane is $10,526 while the Pay-In is $10,505.  So Jane Doe will actually have a loss of $21!  This number is quite different from the commonly used figure of a positive profit of $140 = $10,000 x (5.05% – 2.9%) – $75.

More App-O-Rama Pay-In and Pay-Out can be calculated using this calculator.

Does the arbitrage exist?

It depends.  It depends heavily on the follow factors, in the order of significance: 1) credit limit, 2) duration of the promotion, 3) balance transfer fees, 4) tax rate bracket, and 5) savings APY.  Credit limit is the bankroll.  Duration of the promotion is your play time.  Your bankroll will make money over time, the longer the better, while a short duration reaps you little to no benefit.*  Balance transfer fees, your tax bracket, and the savings APY are all pre-determined.  The only thing you can do is to make sure you are keeping your funds with one of the high yield savings accounts.

Arbitrage does exist! But only for those people ending up with ultra high credit limits (50k, 100k, and more per card).  Someone with a $50,000 credit limit in the 40% tax bracket paying the $75 balance transfer fee and keeping the money in the HSBC savings will actually make $1,436 that year!  However, for someone identical to the above with a $5,000 credit line will only end up with a maximum of $73 in possible profit.  Profit numbers will drop if you relax assumptions 2 to 5.

Why do credit card companies give out such promotion?

There are many possible explanations to this.  The one I find most convincing is that credit card companies price discriminate on their prospective members.  They lower the price (in this case, raise the promotional benefit) to ones with strong financial profiles, identified via high income, high credit scores, and low debt to credit ratio.  These individuals are usually very careful with their finances and have many options on which credit card to get, so it is worth the extra effort to woo them over.  There is the added potential that the individual is a big spender, for which the card company will come out ahead easily with merchant credit charges.  Yes, the rich well-beings do come out ahead on this.  Now, also figure this: how many people with such impeccable financial profile are willing to take out 10 or 20 credit card applications and therefore the credit score dive? 

Concluding Remarks

While credit card companies do take in some sacrifice when acquiring a new card member, the new member may not gain as much as some might suggest.  The only potential big winners out of the App-O-Rama scheme are those who are already starting out with a huge bankroll.  If you do want to partake in this adventure, just be warned that you will likely to end up making less than 50 percent of what some people suggested.  Credit card companies, after all, are not in the business to lose money, regardless of what they tell you.

* One can quickly see that a $10,000 card with 12 month 0% duration yields more than a $20,000 card with a 6 month 0% duration. However, credit limit is more important because that is adjustable whereas the duration is fixed per offer.


About Author

Mark Liu

Mark is responsible for the recruitment of talents and leads the research efforts at Money Economics. He has undergraduate degrees in math and economics and a graduate education in mathematical sciences.

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