Borrowing at a promo rate from a credit card to invest has short-term benefits but requires planning to avoid high fees and market risks.
Q: I received a promotional offer from the credit card company associated with my financial institution. The ad was for a credit card with at least a $10,000 limit at zero per cent interest for the first 12 months. The only debt I have is my mortgage and the credit card I pay off every month. I’m considering taking advantage of the offer and investing the money. I know I can afford payments because I don’t have much debt. I’ve never borrowed money to invest, so I’m wondering, are there any drawbacks to doing this? ~Brook
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A: Leveraging, which is the act of borrowing money to invest, is not a novel concept. It frequently happens when there is significant interest in a particular stock, industry, or trend, such as tech stocks, precious metals, or cryptocurrency. Enticing credit card marketing initiatives, offering low promotional interest rates to attract new customers, can seem like a golden opportunity to borrow money at no cost. These offers can be particularly appealing if you need to make a significant purchase or consolidate existing debt, as they provide a temporary reprieve from high-interest charges.
With that in mind, here are key pros and cons to consider before taking advantage of a promotional credit card offer.
Low/no interest borrowing for a limited time
The most significant advantage of a low or no interest credit card offer is the ability to borrow money without paying much interest for a specified period. If the borrowed amount is repaid in full by the end of the promotional period, it can be a cost-effective short-term financing option. However, the potential downsides can be significant. To fully benefit from the incentive, you would need to make high monthly payments — repaying $10,000 over 12 months means monthly payments of a little over $830. If the debt isn’t fully repaid by the end of the introductory period, the interest rates can jump dramatically and may include interest that accrued but was waived during the promotional period.
It’s crucial to understand all the terms and conditions associated with the offer, as they can vary between credit card companies. Besides large payments, there could be fees for balance transfers, cash advances, or transferring money from the card into a bank account. Balance transfer fees can be as much as three per cent, which on $10,000 would add $300 to your debt. Cash advance fees are typically higher, up to about five per cent, and may not qualify for the low or no introductory interest rate. If excluded from the promotional period, interest begins to accrue on the day the cash is taken. Fees for cash transfers may also apply, typically ranging between one and three per cent of the transferred amount, for credit card companies that offer this service separately from cash advances.
Investing borrowed funds
If you are confident in your investment strategy, borrowing at zero per cent interest and investing the funds could yield a higher return than the cost of borrowing. This could be an opportunity to increase your net worth if you have the financial flexibility to manage potential losses. However, using borrowed funds for investing carries inherent risks. If your investment does not perform as expected, you could lose money while still being responsible for repaying the borrowed amount, possibly at a high-interest rate after the promotional period ends. Depending on the nature of your investment, a downturn in the market can also erode your capital, potentially leaving you in a worse financial position than before.
The impact to your credit rating
Applying for a new credit card and transferring balances can impact your credit score. A hard inquiry from the application process will temporarily lower your score, and a high credit utilization ratio, resulting from borrowing the maximum amount you were approved for, can also have an adverse effect on your score. Depending on the types of credit you use, a high credit utilization ratio could impact future credit applications and make it more challenging to qualify for mortgages or loans.
The bottom line on borrowing money from a credit card to invest
Investing is very personal, and there are many different ways to invest in your future. If you decide to borrow money from a credit card to make investments, maximize the benefits while minimizing the downsides. This requires a solid repayment strategy, and a clear understanding of the terms, fees, and potential tax-related consequences involved. And remember, the ease of borrowing at zero per cent interest can lead to temptation spending and increased debt. Avoid these pitfalls with careful planning, professional advice, and disciplined money management to ensure that borrowing for investment purposes is ultimately a beneficial decision.
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