Margin rates are a financial concept the average investor might not be informed about — and this lack of knowledge could be costly. As a general rule, new investors should stay away from investments that have a margin rate, as they tend to be more complicated options better suited for someone with more experience.
A financial advisor can help you make sense of margin rates and make the right investment choices for you.
What Is a Margin Rate?
A margin rate refers to the cost of the money that you borrow from a broker to buy stocks. Though new investors may sometimes find themselves having to pay a margin rate, it is generally the providence of professional stock traders and sophisticated investors.
Frequently, investors who have been at this for some time will purchase stocks, bonds and exchange-traded funds using a mix of their own assets and money that they’ve borrowed from the broker. The money that the investor borrows is referred to as the margin. The margin rate is how much the broker charges to borrow that money.
Why do investors borrow money to buy stocks, bonds or ETFs in the first place? The same reason an investor does anything — it gives them the chance to make more money. However, if things do not go well, you could also lose your proverbial shirt. Buying investments on margin always involves more risk. The payoff, though, can end up being significant.
If you have a brokerage account and aren’t sure what type of account you have, it’s probably a cash account. You send money from your bank and that money purchases securities. You borrow nothing to fund your investments. You will only be dealing with margin rates if you have opened a margin account.
How Are Margin Rates Determined?
Typically, margin rates are 3% to 12% of the notional value of the contract. Your brokerage will decide how much to charge, but as you can imagine, brokers are competing with each other and trying to attract investments – and so they tend to be fairly close to each other and offer whatever the market demand will support.
Margin rates also generally line up with whatever the Federal Reserve is doing. If the Fed is in the midst of raising interest rates, your margin rates are probably going up as well. Other factors can play a part in deciding the margin rate as well, such as how much money you have in your margin account. The more you invest, the less your margin rate may be, depending on the brokerage you are working with.
Margin Rates FAQ
There are a few more pieces of information about margin rates that may come in handy to know, if you do decide to take out a margin loan. For instance:
- Margin rates accrue daily and are charged on a monthly basis. The more you pay in margin rates, the more than eats into the profits you’re making when investing. That’s why investment traders often engage in short-term trading purposes when they take margin loans. It’s typically considered not a good idea to take out a margin loan for a long period of time.
- Typically, when it comes to setting a margin rate, a brokerage will establish a base rate and then add another percentage. Depending on the assets you have with the brokerage will determine how high or low that percentage is. So if a brokerage has a base rate of 10.25%, everybody who applies for a margin loan will pay that rate – plus something else. For instance, if you have $10,000 in your margin account, you might pay a base rate + 1.825%, while the borrower with $100,000 in an account pays the base rate + 0.325%. The investor with half a million in the account will pay a base rate and may pay an even smaller additional percentage, like 0.075%.
- Margin rates can change at a moment’s notice. You could have a margin loan with a brokerage and the rate could go up or down – and you might not even be alerted by your brokerage. That’s another reason to be wary of investing with margin loans.
The Bottom Line
Newcomers should stay away from opening a margin account until they have a good feel for investing. Margin loans often pay off handsomely for some investors – that’s why they exist, after all – but if you’re new to this, or even if you’re an established investor, you could end up owing and losing a significant amount of money. When it comes to understanding margin rates, there’s really no margin for error.
- For help managing complex investments, consider working with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- To see what your investments could look like down the road, use SmartAsset’s free investment calculator.
Photo credit: ©iStock.com/mediaphotos, ©iStock.com/BongkarnThanyakij, ©iStock.com/Neyya