Margin interest is the interest that is due on loans made between you and your broker concerning your portfolio assets. For instance, if you sell short a stock, you must first borrow it on margin and then sell it to a buyer. Or, if you purchase on margin, you will be offered the ability to leverage your money to purchase more shares than the cash you outlay. For example, with 10% margin you may buy $1,000 worth of shares while putting up just $100. That extra $900 is granted to you in the form of a margin loan, for which you will have to pay interest. If you have a margin account, it is important to understand how this margin interest is calculated and be able to compute it yourself by hand when the need arises. It's just as important as the interest on your savings account.
Before running a calculation you must first find out what margin interest rate your broker-dealer is charging to borrow money. The broker should be able to answer this question. Alternatively, the firm's website may be a valuable source for this information, as should account confirmation statements and/or monthly and quarterly account statements. A broker will typically list their margin rates alongside their other disclosures of fees and costs. Often, the margin interest rate will depend on the amount of assets you have held with your broker, where the more money you have with them the lower the margin interest you will be responsible to pay.
Margin Interest Calculation
Once the margin interest rate being charged is known, grab a pencil, a piece of paper, and a calculator and you will be ready to figure out the total cost of the margin interest owed. Here is a hypothetical example:
Suppose you want to borrow $30,000 to buy a stock that you intend to hold for a period of 10 days where the margin interest rate is 6% annually.
In order to calculate the cost of borrowing, first take the amount of money being borrowed and multiply it by the rate being charged:
$30,000 x .06 (6%) = $1,800
Then take the resulting number and divide it by the number of days in a year. The brokerage industry typically uses 360 days and not the expected 365 days.
$1,800 / 360 = 5
Next, multiply this number by the total number of days you have borrowed, or expect to borrow, the money on margin:
5 x 10 = $50.
Using this example, it will cost you $50 in margin interest to borrow $30,000 for 10 days.
While margin can be used to amplify profits in the case that a stock goes up and you make a leveraged purchase, it can also magnify losses if the price of your investment drops, resulting in a margin call, or the requirement to add more cash to your account to cover those paper losses. Remember that whether or not you gain or lose on a trade, you will still owe the same margin interest that was calculated on the original transaction.
To learn more about margin, see the Margin Trading tutorial.