I’ve written many times about my fondness for low-interest, and especially low-fee, balance transfer and cash advance credit cards, which allow consumers to borrow large — sometimes very large — sums of money for a fixed period of time and pay nothing to the bank if the loan is paid off by the end of the promotional period.
This is a form of what I think of as “institutional arbitrage,” which is possible when different categories of institutions are able to borrow and lend across what should be, but are not, airtight boundaries. This kind of institutional arbitrage is the underlying mechanism for a lot of both travel and personal finance hacking.
My five favorite uses for low-interest loans
- Swap secured for unsecured debt. A classic example here is something like a car loan that is secured by the vehicle itself. While interest rates on car loans aren’t particularly high right now, you might prefer to extinguish your secured car loan with an unsecured, loan-interest credit card loan, so you can keep your car if pressed into default on the unsecured credit card debt. In an even more complicated version of this strategy, you might use unsecured, low-interest credit card loans to pay off student loan debt, which in most jurisdictions is undischargable even in bankruptcy!
- Make or accelerate “use it or lose it” retirement contributions. I’ve written before that “use it or lose it” is the most important feature of retirement accounts. When you let a calendar year’s contribution deadline pass (usually that year’s tax filing deadline), you’ve permanently reduced your ability to shield dividends and capital gains from annual tax assessment. Taking out a low-interest loan to maximize your annual contribution allows you to lock in guaranteed tax savings, and work out the details later.
- Meet intermediate financing needs. Some businesses, like resellers, find deep discounts on merchandise while it’s out of season or out of favor. Swimming trunks in January, fur coats in August, and so on. They may want to hold onto the merchandise until it’s back in season or back in fashion, and low-interest loans are one way of financing that intermediate-term inventory.
- Meet high balance or deposit requirements. Earning the highest possible interest rate on your cash savings has always required a bit of legwork. I assume back when interest rates were kept artificially low, our ancestors would open bank accounts all over town in order to collect as many toasters as possible to sell to their friends and family. The same principle works today: accounts that offer nothing in interest on your deposit will still offer a cash signup bonus to attract your business. The deposit requirements, however, can be substantial: as high as $50,000 in the case of Citi’s current $700 bonus. But if you’re playing with the house’s money, that’s a higher interest rate than you’re likely to earn on any other safe investment. Similarly, you might consider funding certificates of deposit with rewards-earning credit cards and then using low-interest loans to pay off your credit balances before any interest is owed.
- Get cash discounts. I grew up hearing stories, which I choose to believe are true, but have no evidence of whatsoever, that when my father needed a new car, he would walk in the dealership with a briefcase full of cash and make the dealer an offer he couldn’t refuse. In the consumer world I don’t think there are very many “cash discounts” still available, but in business-to-business interactions I imagine there are still companies willing to accept less, perhaps much less, if you’re willing to pay in cash up front. The reason most businesses aren’t able to do so is they rely on the lag time between their purchases and sales to finance their operations! But if a low-interest loan allows you to settle immediately in cash, you may find vendors as flexible as my dad (allegedly) did.
Hopefully the above examples illustrate why I call this “institutional arbitrage.” If Discover could deposit $50,000 with Citi and earn $700 in interest, they surely would. But Citi doesn’t offer $700 signup bonuses to other banks — it only offers them to consumers, so the consumer becomes the intermediating institution. The consumer can take out a consumer loan from one bank, make a consumer deposit in another bank, and earn a return that the lender would not earn and the depository would not offer on their own. Hence, institutional arbitrage.