Saturday, June 16, 2012

Interest rate arbitrage

Don't try this at home, kids.

Around the time I paid off my first student loan, I applied for another credit card. I had heard good things about Discover and I don't need my credit for anything in particular going forward. I had an ulterior motive though.

Back in my non-Mustachian heyday as a college student I played a little game with credit cards. First, some background. I went to a private university, and an expensive one at that (though what private universities aren't expensive these days?), and had my way paid for me through a combination of scholarships, student loans, and parents. I made it a point not to work during school so as to focus on schoolwork. In my defense, I finished with a good GPA and I worked and saved up money every summer. Still, I didn't have a lot of cash money, and I was fine with that because I was fully expecting to be well-off after I got out of school. (Now that I think about it, that's a bit of revisionist history. I planned on going into a PhD program so it would have been years before I got a good salary.)

My first two years I signed up for the college-provided meal plan. It was decent food but mondo expensive. In my junior and senior years I opted to cook for myself, and that decision probably saved me between $2k and $3k a year. I knew that signing up for the meal plan would be the easy way out. It would also be paid for with future money, and potentially my parents money, but a 2x markup is pretty steep. I guess I would have to pay for my food out of my meager cash savings. Unless...

Unless I could use future money without using student loans. I'm talking, of course, about credit card debt! Don't worry, I wasn't totally insane. I managed to score two credit cards at 0% interest for 12 or 18 months (the details are fuzzy, I think it was an Amex Blue and a Citi Mastercard). The limits were low, like $2k or $4k. That way I got to keep my cash while still buying foodstuffs to keep from starving. The low limits were a boon, too, because I could still feel poor without having to pay cash for things.

I kept those cards at or near their limits for months on end. Often times I would need to pay more than the minimum payment so I would have room for new purchases. This whole process took a lot of fine tuning. I wouldn't recommend it if you don't plan on being very hands-on with your money. When the introductory APR period came up I would either pay the card off in full, if I had the cash, or I think once I needed to balance-transfer the money onto another 0% card (and eat the $30 fee).

It was a dangerous game I was playing. I didn't pretend otherwise, though in my youthful swagger I didn't really have a concept of what exactly could go wrong and just how wrong it could go. To tie that story up, I managed to pay off all my credit card debt during my one year of grad school, on a stipend of $18k/yr. I kept my living expenses low and I'm pretty happy about it, though part of that should be considered a debt rollover since I took out the maximum I could in Stafford loans.

I knew some things about money, but I certainly did not know everything.

Fast forward to today. I've seen the light of Mustachianism as delivered by our wise mustachioed sage. I've been aggressively paying off my accumulated student loan debt for over six months now. I make an obscenely large amount of money and I live an over-the-top flippantly luxurious lifestyle. And the thought crept into my brain: could I use credit card introductory teaser offers to accelerate my student loan debt paydown?

I've started down a dangerous path once more. Since I got my 0% Discover card in May, I've been charging anything I can to it instead of my other cards. I will only be paying the minimum. This will free up a few hundred dollars of cash per month which I will be using to pay off my loans. I've also gone one step further by charging some joint account purchases to the Discover card and reimbursing myself with cash from the joint checking account (having cleared this with my girlfriend first, of course). In this way I can borrow money at 0% to pay off my student loans at 6%.

I'm taking on additional cash flow related risk with this little maneuver. I'm also taking on the risk that I'll buy things I wouldn't have ordinarily bought because I don't have to pay for them right away. The benefit is something on the order of $100/mo of interest I'll save by paying off my student loans earlier (0.5%/mo on $20k is $100. I have over $25k student loan debt outstanding.)

I've been grappling with what my personal stance on debt should be. But this post is a lot longer than I had originally intended, so I'll pontificate some more tomorrow.


  1. Interesting gaming of the system. Your right in that you are playing with matches in the middle of a fireworks factory here, but at the same time the fireworks are all a good couple of meters away. I applaud this usage of credit cards and that $100 a month is REAL MONEY. That's $1,200 a year. If I was suddenly told I'm getting a $1,200 a year bonus I'd be thrilled. If you can keep unneeded purchases out of the picture this could be a great strategy at debt pay-down.

  2. Your personal stance on debt should be, to quote MMM, "it's a FLAMING EMERGENCY!" Watch that part of your life that is living over the top with a flipping luxurious life style!

    That being said, I'm not following your hare-brained scheme exactly, but MMM has given us a precedent. He is strongly against the Dave Ramsey style 6 months of living expenses emergency fund, if you have any debt. Better to keep a small checking balance (mine is about one month of normal expenses) and put the rest of the savings, which earns about a 1/2 percent these days, against that expensive debt. This assumes that in an emergency, you have some kind of credit line available to fix that car or water heater or whatever.