Investor Bulletin: Interested in Margin? Understand Interest.

The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to help investors ask informed questions about the interest a brokerage firm charges for margin accounts.

 A “margin account” is a type of brokerage account in which your broker-dealer lends you cash (“margin loans”), using the securities and money that you hold in your account as collateral, to purchase additional securities (known as “margin securities”). Margin increases your purchasing power, but also exposes you to the potential for larger losses. For more information on how margin accounts work and their risks, please read our Investor Bulletin, Understanding Margin Accounts.

Interest Charges – Money is not free.

As with any loan, you will be charged interest on your margin loan by your broker-dealer. This interest directly reduces your return on investment, increasing the amount your investment needs to earn to break even. You should carefully consider this expense before trading on margin.  Interest rates can vary substantially between brokerage firms.

In addition to the interest rate that a broker-dealer charges on margin loans, you should also consider how the firm handles interest charges to your account. Some broker-dealers may sweep the cash you have in your “cash account” at the firm to your margin account to reduce your margin loan and the interest that you have to pay (“netting”).   

Here is a simple example of how netting may work. You use a $50,000 margin loan to purchase securities in a margin account, and you also have $50,000 in cash in your cash account at the firm. The interest rate applicable to the margin loan balance is 7 percent annually, while the interest paid on your cash balance in your cash account is 1 percent.

No Netting Policy

A broker that does not net your accounts will charge you interest on the full $50,000 margin loan. You would pay $3,500 annually (approximately $9.59 per day) in interest, unless you reduce your margin loan, for example, by adding cash to your margin account; while earning $500 annually (approximately $1.37 per day) in your cash account. Your net cost is $3,000 annually ($8.22 per day). The cash in your cash account will not reduce your margin loan and will have no impact on the interest rate charges in your margin account.

Netting Policy

A broker that nets your accounts will not charge you interest on the margin loan because the cash balance in your cash account that is swept into your margin account equals the balance of the margin loan.  In this example, your firm would not charge you interest because the amount of cash swept from your cash account and the amount of the margin loan net to zero ($50,000 loan versus $50,000 cash). That is, you would not pay $3,500 annually ($9.59 daily) for the margin loan and you also would not receive $500 annually (approximately $1.37 daily) as interest for the cash balance; compared to the example where the broker has no netting policy, here you would be saving $3,000 ($8.22 daily).  However, in this example, if your cash account balance was below $50,000, your firm may charge you interest on the difference between the amount of the margin loan and the cash account.

Not every brokerage firm nets your cash and margin accounts, and not all netting policies work the same way. Ask your brokerage firm if they have a netting policy, and if so, ask them to explain it.

How does your brokerage firm handle interest charges in a margin account?

Read Your Margin Agreement

To open a margin account, your broker will have you sign a margin agreement.  The margin agreement may be part of your general brokerage account opening agreement or may be a separate agreement.  As with most loans, the margin agreement explains the terms and conditions of the margin account.  For example, the agreement describes how the interest on the loan is calculated, how you are responsible for repaying the loan, and how the securities you purchase serve as collateral for the loan.  Carefully review the agreement to determine what notice, if any, your firm must give you before either selling your securities to collect the money you have borrowed or making any changes to the terms and conditions under which interest is calculated.  In general, a firm must provide a customer at least 30-days written notice of changes in the method of computing interest.

Ask Your Brokerage Firm

Ask your brokerage firm to explain how interest charges accrue in a margin account.

  • What is the interest rate on margin loans?
  • Can this interest rate vary?  If yes, then how often does it change and where can you find those changes?
  • How often do interest charges accrue on the margin loan balance (daily, weekly, monthly)?
  • How can you reduce the margin loan balance?
  • Does the firm net your cash account balances and margin account balances to reduce the interest you pay on margin loan balances? Does it matter whether your cash and margin accounts are set up in a certain way (e.g., as separate accounts or as “sub accounts” with one master account)?
  • If so, how does the firm’s netting policy work with your accounts?
  • How do cash or money market sweep programs (where your extra cash is swept into a bank account or money market account) impact the firm’s netting practices?

Additional Resources

Investor Bulletin: Understanding Margin Accounts

For additional investor education information, see the SEC’s website for individual investors, Investor.gov.

Call OIEA at 1-800-732-0330, ask a question using this online form, or email us at [email protected].

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Source: SEC

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