Margin Trading Facility: Meaning, Interest Rate Charged & Penalty
Facing a lack of funds but still want to indulge in trading? Don’t worry, as the margin trading facility offered by various stock brokerages will allow you to trade on margins just by paying a fraction of the total transaction value.
However, margin trading facility comes with certain interests that brokerages levy upon their clients. Therefore, it becomes pertinent for you to understand all the intricacies related to interests related to this trading facility. This article will give you an idea about the interest charged on the margin trading facility.
What Is Margin Trading Facility?
It is a facility where you can buy or trade stocks just by paying a nominal or fractional amount of total transactional value. With the help of this facility, you can undertake trading in stocks which you cannot afford.
You can pay off the margin amount either in cash or pledging shares, which can serve as a security. The amount of the said transaction is funded by your brokers. The settling of the margin will take place at a later stage when you square off your position. You will be in the profitable category when profits earned are quite higher than margins paid.
This trading occurs under certain stringent conditions of the Securities and Exchange Board of India (SEBI). It makes all the rules regarding interest levied for funding margin trading and penalties that brokers can levy on their clients in case of default on interests.
What Is the Interest Levied on Margin Trading Facility?
The interest charges on these trading activities and subsequent revenues from them serve as one of the most crucial revenue streams for brokerage houses. Profits that they earn from margin trading facilities will allow competitive and efficient brokerage rates for other clients.
Interest rates on margin trading facilities may remain fixed as per the terms and conditions agreed upon by both parties. However, there is always a chance of negotiation for cheaper interest rates. This negotiating or bargaining power depends on your personal relationship with brokers as well as the total value of the margin trading transaction.
Different brokerages follow different methods of computing the loan amount. Therefore, it is always wise if you talk to your brokers directly regarding the computation process or get a better idea about it by looking at their website.
Usually, brokers take the annualised interest rate and multiply the same with the borrowed amount. After that, the output obtained gets multiplied by the tenure of such loans. In case you opt for a margin trading facility for 35 days, you shall multiply the output by 35/365 to compute the interest amount.
What Is the Formula for Calculating Interest in a Margin trading Facility?
The formula for interest payable is as follows:
Interest = (Interest rate/365) X Principal amount X time;
Here, interest rate represents annualised interest rate that brokerages charge on loan amount;
Principal represents the loan amount;
Time is the tenure of the said loan amount.
Now let’s see how brokerages determine the principal amount. It is derived by a very simple process, and a margin account functions in the same manner as an overdraft account. The easiest way of determining the loan amount is by calculating the equity in your account and subtracting the same from the prevailing market value.
In case the output is a negative value, it will be the loan amount on which you have to pay interest. You can take it as a principal and calculate interest on it. On the other hand, if the output after subtraction comes down to zero, it means that you do not have to pay anything.
However, if the output is a positive value, you withdraw that amount from respective margin accounts and deploy the excess cash in some other investment opportunity, as margin account does not offer anything significant.
You must remember that this is the most generic way of computing the principal and corresponding interest amount. Every brokerage house complies with its own methods, and it is important to get a clear idea by talking with them directly.
Is There Any Penalty on Unsettled Margin?
However, there is also a provision of penalty for non-settlement of margins.
Brokerages can levy penalties under the guidelines of SEBI. It is levied on trades undertaken without any adequate margins. SEBI has defined adequate margins in their regulations.
In futures and options segments, the margin would be Exposure Margin + SPAN Margin. On the other hand, for equities, margins would be ELM + VAR + Ad hoc Margins in equity. Moreover, the applicable margins will deal with net buy premium if you are going for purchasing options.
Brokerages will levy penalties on short collections by every client. The percentage points of various penalties under this mechanism are as follows:
- If the shortfall is less than ₹1 lakh and lower than 10% of the concerned margins, penalties are levied at the rate of 0.50%.
- On the other hand, if the shortfall crosses ₹1 lakh and is equal to or more than 10% of applicable margins, the brokerage shall levy a penalty at the rate of 1%.
A margin trading facility is an efficient mechanism that you can use to undertake immediate trading requirements when you are facing a fund crunch. As it is a loan that brokerages provide to their client, interest is charged on the margin trading facility. Therefore, it becomes imperative that you consider all aspects related to interest rates and proceed accordingly.
Frequently Asked Questions
What is the interest rate on the margin facility?
Usually, brokerages charge anywhere between 15-18% on an annualised basis. However, it is just generic information, and the final interest rate may vary depending on a number of factors, like your relationship with the brokers and the transaction value.
What is the holding period of stocks bought under margin trading?
There is no restriction on the holding period of stocks under the margin trading facility. You are free to hold them as long as you are able to maintain margins in the account.
What is a margin trading facility pledge?
According to the Securities and Exchange Board of India (SEBI), shares purchased under the margin facility shall be mandatorily pledged. Moreover, you will not receive any additional benefit against corresponding shares.
After how many days will I start incurring interest in margin trading?
In margin trading, you shall start incurring interest from the second day onwards after placing a trade. It shall continue till you clear the total amount or square off the open position.