Part 4: Why Manufactured Spending is like Russian Roulette
In Part 2 a few weeks ago, I taught you how to pay your rent and other large expenses with a credit card and earn points even if the payee doesn’t directly accept credit. If you’ve been curious about the subject and researched further on it, then you may have encountered a tactic called “manufactured spending”. What I’m about to tell you is not something I partake in on a regular basis but it’s important to educate you about it if you’re even considering this route.
What is Manufactured Spending
Manufactured spending is the process of buying items with your credit card that can be quickly converted back to its original cash value (or very close to it, without directly returning the item), earning free credit card rewards in the process. You can think of it as a special form of arbitrage. For example, if you have a credit card that gives you 2% cashback or the equivalent in rewards and purchase a $500 gift card for $506 total, you’ll earn $10.12 in rewards. Then you liquidate the $500 gift card and get back the $500 which you can use to repeat the process over and over again. Your total profit is: -506 + 500 + 10.12 = $4.12.
Why Isn’t Manufactured Spending a Good Idea
It cloggs up credit card companies’ resources.
In order to make $8000 (or the equivalent in rewards) through manufactured spending, you’d have to churn through a total of about $1 million dollars worth of gift cards with the setup I mentioned in the previous section. That’s a ton of ACH transfers as you constantly pay back the credit card in order to stay below your credit limit which taxes the credit card issuer’s resources on top of them having to pay you the rewards. It’s no surprise that they’d be looking to drop you as a customer if you do this on a large scale.
It may draw the IRS’s attention.
When large sums of money are deposited into you bank account on a regular basis, the IRS starts noticing, especially if the amount easily dwarfs your annual salary. Although Manufactured Spending isn’t illegal, the Feds will start getting suspicious and it’s up to you to prove your innocence and that you’re not involved in other illegal schemes like money laundering. You’ll likely come under closer scrutiny and likely spend a great deal of time having to explain to the Feds what you’re doing and why.
Occasional glitches can set you back
Sometimes you might buy a gift card that’s defective. Or the ACH transfer to pay back your credit card fails for some unknown reason. Or the credit card “misplaces” the money it has received in paying back your card and blames you, charging you a late fee which you need to resolve. While these sorts of glitches are atypical for a normal user of credit cards, their probabilities only go up when you churn ungodly volumes of money through your credit cards on a regular basis. If you don’t have an emergency fund and you find out the $5000 in gift cards you bought today are all defective, you still have the law on your side in getting your money back but it probably won’t happen in time before your next mortgage or rent is due.
It’s Time Consuming
It takes time to go to a store to buy gift cards with your credit card and then liquidate those gift cards at Walmart. This is time that you won’t be getting back. In order to make about $20 per hour, assuming a 2% cashback, you’d need to churn roughly 5 credit cards every hour. Unless you’re unemployed or have no marketable skills, it’s most likely not the best use of your time to be honest.
The only time I recommend Manufactured Spending
If you’re gonna engage in manufactured spending, then you must fly under the radar and not amass massive amounts of points using this shady method. In other words, you cannot churn a ton of money and not expect your credit card company or the IRS to notice. But you can’t earn many points this way either. So there’s only 1 situation where, IMO, manufactured spending is useful: when you’re only a few thousand points away from a reward.
Suppose you plan on booking a plane ticket in the near future and have 30,000 points but need at least 35,000 points for the ticket. You’ll need to spend $5000 to earn those points but unless you’re a big spender, it’s not gonna happen very quickly. In this case, go ahead and use manufactured spending to earn those 5000 points and be done with it.
Thoughts in Summary
Although manufactured spending is legal as of 2015, it’s not gonna earn you a good reputation with your bank and credit cards as you consume disproportionate amounts of their resources while you churn credit cards like there’s no tomorrow. Besides, it’ll also attract the IRS’s attention since it resembles some types of illegal activity from the outside. The only time I recommend this tactic is if you’re only a few thousand points away from being able to redeem a particular credit card reward since manufacturing the spending of a couple thousand dollars is highly unlikely to raise any eyebrows.