Robinhood Lowered Margin Rates to Below 7%. Here's Why I'm Steering Clear

Margin is risky, and I didn't understand the risks going in. I didn't realize that brokers can force you to sell when your stocks hit certain lows. Not realizing it cost me a lot of money, and it's a big reason I'm steering clear of most margin, despite good rates.

Robinhood and I have played this game before. Robinhood advertises great rates. I fold. The stock market plummets, and I lose thousands of dollars to margin calls. Etc, etc.

But it'll be a cold day in sunny California before I make the same mistake twice. Sure, Robinhood has done the impossible. It's slashed margin rates almost in half, from double-digits to less than 7%. Its rates are lower than almost every other broker's.

But I'm steering clear of margin regardless -- with one key exception. Read on for a great reason to steer clear of margin (besides margin calls) and why I'm making an exception.

Interest payments eat into profits

Margin, or borrowing money from your broker to invest, is risky for a handful of reasons. In the stock market, you make money buying low and selling high. Margin complicates this. You need to buy low, sell high, and also pay variable interest. Interest will eat into your profits. On bad days, it will even worsen your losses.

When I first borrowed margin from Robinhood, rates were low. I'm talking a few percentage points. I paid so little interest, I felt it was worth the risk. That changed when the Federal Reserve hiked interest rates -- and did so faster than the U.S. had ever seen.

By then, I was paying double what I'd planned. Brokers can change rates on you. It's not like taking out a fixed-rate loan. Your interest rate can go up or down based on what your stock broker thinks is appropriate.

Robinhood has lowered margin rates to below 7%, but it's still too risky to justify. Its rate is low compared to other brokers, but I'm not interested in making that kind of commitment.

Interest-free margin is okay

Margin is risky, but there are minor exceptions to the rule. Robinhood offers 0% interest to Robinhood Gold subscribers. This applies to the first $1,000 of borrowed margin.

I happen to like that deal. I'm already a paying Robinhood Gold member (for a 3% IRA match), so I'm already paying the $5 monthly fee. 0% interest rates lower the risk threshold of taking out margin. Even if my account plummets in value, $1,000 is too small a percentage of it for me to be called.

Worst-case scenario, I withdraw from my savings account and pay the $1,000 in a snap. This time, I won't be caught paying off margin for months while I cobble together funds.

So I'm borrowing a bit of money from Robinhood to boost my investments. It's still riskier than borrowing nothing at all, but for me, the zero-interest risk is worth the reward.

Should margin users switch to Robinhood?

Yes, if you're already borrowing money at rates above 7%. Interest payments add up. If you use margin now and plan to keep using it, and if Robinhood offers better rates, you may want to switch. It could save you thousands over the long term.

The exception is if your broker offers something Robinhood doesn't. Say, for example, extensive research or charting platforms. Robinhood does a bit of charting, but it lags behind other brokers. It offers some Morningstar research to Robinhood Gold members, but again, it lags.

Some brokers charge you fees for transferring stocks between brokerages. Fees are typically $50 to $100. If that's too much to pay, then stick to your broker.

Alternatives to margin investing

Robinhood offers other compelling perks that require zero borrowing, including the following.

IRA match: Robinhood will match deposits into your IRA by 1%. So if you deposit $7,000, it will deposit $70. Robinhood matches the deposits of Robinhood Gold members by a whopping 3%. If I deposit $7,000, Robinhood will match me $210. This covers the membership fee three times over.

$0 commission trading: You can trade stocks, ETFs, options, and crypto without paying commissions. Robinhood is one of few brokers that charges $0 for options and crypto trades. The most notable fee is the membership fee, which is optional.

I'm sticking with my Robinhood account. Not for low margin rates, but because it lets me invest without paying a ton of fees. The $1,000 of interest-free margin it gives me is a neat bonus, but it's nothing to write home about. New investors should steer clear of borrowing margin.

But if you like other perks Robinhood has to offer, it's worth checking out. Along with SoFi and Fidelity, it's one of the best stock brokers out there as of June 2024.