When traders use a margin account — which allows them to borrow money from their brokerage to make trades — they’re charged margin interest on the funds they borrowed. It’s similar to using a line of credit.
Living life on the margins may not sound appealing to many people, but for some investors — especially those making a lot of trades — it’s simply a part of the game. Many traders buy and sell securities “on margin” in order to place bigger bets than they normally would. The amount of interest charged is typically a function of how much the trader borrows.
In order to get the most from margin trading, it pays to understand how margin interest is calculated, and how and when to deduct it on your taxes. We explain it all below.
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What is Margin Interest?
As mentioned, margin interest refers to the interest charged on a trader’s margin debt: i.e., the balance owed on their margin account.
Just as you can borrow against the equity in your home via a line of credit, you can also borrow against certain investments in your portfolio. This is called margin lending, and it happens within a margin account, a type of account available at most brokerages.
Margin Accounts vs Cash Accounts
With a cash account, you can only buy as many securities as you can cover with cash. If you have $20,000 in your account, you can buy $20,000 worth of investments. By contrast, a margin account allows you to borrow from the brokerage to purchase securities that are worth more than the cash you have on hand. The assets in your account effectively act as the margin or collateral for any funds you borrow.
As an example: If your brokerage offered you 10% margin, you can use $1,000 to buy $10,000 worth of investments.
Most brokerages provide the option of making a taxable account a margin account. FYI, tax-advantaged retirement accounts like traditional IRAs or Roth IRAs are typically not eligible for margin trading.
Margin Accounts and Risk
Margin accounts are generally considered to be more appropriate for experienced investors, since trading on margin means taking on additional costs and investment risks. Trading on margin can amplify your gains, because you can afford to invest more, but conversely there is also the possibility that any losses would likewise be steeper.
In the event of a loss, a margin call may require your broker to sell assets from your account to cover your balance, without notification. Thus, in addition to facing a loss if your trade isn’t profitable, you would still be on the hook for repaying any margin debt plus interest.
How Does Margin Interest Work?
Each brokerage will have its own guidelines and rules relating to margin loans, and they must be at least as strict as those prescribed by law. That is, the brokerage will dictate which types of stocks, bonds, ETFs, etc., that are “marginable,” or that traders can buy on margin. For instance, a brokerage may decide that traders can only buy stocks that are listed on U.S. stock exchanges on margin, and that have a value of at least $10 per share.
In addition, the Securities and Exchange Commission (SEC), FINRA and other regulatory bodies have rules you need to know, in addition to understanding the policies of your specific brokerage. For example, FINRA requires that you deposit the lesser of $2,000 or 100% of the purchase price of the stocks you plan to purchase on margin.
Again, terms may vary from brokerage to brokerage, but with these basics in mind it’s easier to understand how margin interest works.
Once you qualify for a margin account and purchase a stock on margin, for example, you’ve essentially bought that security with credit and now have to pay back the loan with interest.
Margin interest rates, similar to rates on a line of credit, vary depending on the brokerage. The interest you owe is typically higher when you’ve borrowed lower amounts. The lowest margin interest rate is generally applied to traders with higher balances.
Margin Interest Example
Here’s a hypothetical example: let’s say Brokerage A’s margin interest rates were between 4% and 8%. Traders using up to $24,999 in margin might be subject to the highest interest rate (8%), whereas traders with more than $1 million in margin debt would be charged the 4% rate.
Brokerage B, though, could have different terms, with margin debt up to $24,999 subject to an 8.5% margin interest rate, and those with debit balances between $250,000 and $499,999 subject to 6.5%.
While in many cases, the repayment of your margin loan is up to you, interest charges are automatically posted to your account on a regular cadence (e.g., monthly), similar to a credit card. To minimize the amount of interest you’re charged, it’s wise to have a plan for reducing the amount you owe. This can be done by selling securities or depositing cash into your account.
In theory, you could pay off a margin loan before much interest had time to accrue. But, as with other forms of credit, the interest on your margin loan may be charged daily.
How is Margin Interest Calculated?
Okay, so now you have a basic understanding of trading on margin, and margin interest. The next big question: How is margin interest calculated?
To calculate margin interest, there are two key variables at play: The loan balance, and the interest rate. The size of your balance (we’ll call it a loan, for simplicity’s sake) generally determines the effective margin interest rate, too.
In simple terms, here’s how margin interest would be calculated: The loan, multiplied by the effective interest rate, divided by 360 (the brokerage industry generally uses a 360-day annual calendar, rather than 365). This calculation gives you the daily interest charge.
As an example, say you borrowed $10,000 to buy Stock X. You think that Stock X will gain value over the next two weeks, so you plan to hold it for 14 days, and then sell. Your broker will charge you an effective interest rate of 8.5%.
It bears repeating that the stipulations and specifics will depend on your brokerage. So be sure to check the documents in your account to know what you’ll be charged.
Back to our example — with these variables in hand, we can calculate the margin interest we should expect to pay. Here’s what the calculation would look like, step by step:
• Step 1: Multiply the margin debt and the effective interest rate.
$10,000(.085) = $850
• Step 2: Divide the annual interest charge by 360 to get a daily interest charge.
$850 ÷ 360 = $2.36
• Step 3: Multiply the daily interest charge and the number of days you’ll hold Stock X.
$2.36(14) = $33.04
With that, we now know that it’ll cost about $33.04 in margin interest charges to buy $10,000 of Stock X on margin and hold it for 14 days. Remember, this is a pared-down, simplified version of this calculation. But this should give you an idea of how margin interest is applied and accrued.
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Margin Interest Tax Deductibility
Another important question that many investors ask: Are margin interest charges tax deductible?
The short answer is yes. Though there were some changes made to what types of itemized deductions can be made a few years ago relating to a tax reform bill and investments — changes that started in 2018 and will phase out in 2025 — the investment interest deduction wasn’t one of them.
Margin interest is, technically speaking, an investment expense. So if you borrow money to make investments, and itemize your deductions on the Schedule A portion of your 1040 tax form, it’s likely you can deduct margin interest up to the amount of your net taxable investment income. So, calculate your total net investment income, and that number is the limit of how much you’re able to deduct for margin interest. You’ll use Form 4952 for the deduction.
The devil is in the details when it comes to taxes and specific deductions, like this, however. For that reason, it may be best to consult with an accountant or other professional to make sure these deductions are the best way to shore up your tax efficient investing strategy.
Like most forms of credit, margin loans — i.e., borrowing money from your brokerage to buy securities — must be repaid with interest. Understanding the terms of your brokerage’s margin account means learning what the margin interest rates are, and how they apply to you. Typically, higher margin balances are charged lower interest rates.
That doesn’t mean you can trade more on margin to get a lower interest rate. Industry regulations, in addition to the rules of your brokerage, restrict how much you can borrow — and how much you must keep in your account as collateral.
Margin trading, as noted above, is a feature better suited to experienced investors owing to the possibility of losses. SoFi offers margin investing at one of the most competitive rates in the market. You can open a margins account today and take advantage of increased buying power at 2.5% interest* while expanding your investment portfolio.
Photo credit: iStock/Eva-Katalin
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