What Is a Rebate?

What Is a Rebate?

Let me explain what a rebate is to you directly. In general, it's a sum of money returned to you as a buyer after you've completed a transaction, or it can be a fee that a short seller pays to the owner of the securities they've borrowed.

If you're involved in a short-sale transaction, the rebate is specifically a portion of the interest or dividends that you, as the short seller, pay to the owner of the stock or bond shares you're selling short. Remember, short selling always requires a margin account.

Broad Definition of Rebates

Broadly, you get a rebate as a credit or return of money after buying something. This could be cash back on a consumer product or service. It might come as a flat-rate rebate subtracted right from the purchase price, or a conditional one that's only valid if you meet certain conditions, like 'buy one, get one free.' For some conditional rebates, you have to submit a form with proof of payment to the company to claim your cash back.

Understanding Rebates

Businesses offer rebates for several reasons, primarily because they're effective marketing tools that draw you in with the promise of cash back on pricey items. Even if a company takes a loss on the rebated product, they often find ways to profit overall. For instance, when you buy a rebated item, you might pick up other things in the store, leading to a net gain for the business.

Some companies use rebates to 'price protect' certain products, offering rebates on others to keep higher prices on the rest. This strategy helps maintain sales without cutting prices across the board.

Mail-In Rebates

You're probably familiar with mail-in rebates as one of the most common types for consumers. They require some effort on your part, like filling out forms and sending proof, which means not everyone bothers to claim them. Businesses factor this in; they know only a portion of customers will follow through, so the average price reduction ends up less than the full rebate amount.

Vehicle Rebates

Rebates are often available on new vehicle sales. Usually, the manufacturer covers the rebate, not the dealer—they give the money to the dealer, who then passes it to you if you qualify. By law, dealers must give you the full rebate amount. Keep in mind, though, that rebates can lower the resale value of vehicles by effectively reducing the sticker price.

Rebates vs. Discounts and Reduced Interest Rates

You collect rebates after you've paid, unlike discounts which you get before purchase. Retailers tend to offer discounts, while manufacturers like automakers provide rebates. Reduced interest rates, on the other hand, cut your monthly payments on big buys like cars.

When buying a car, you might have to choose between a rebate or a lower interest rate. The rebate gives you cash right away, but the lower rate could save you more over time.

Rebates in Securities Trading

In financial markets, if you're a short seller, you're betting that a stock or asset will drop in price. You sell securities you don't own by borrowing them from the owner and delivering to the buyer. Your goal is to buy back at a lower price later to profit.

Short selling carries unlimited risk because the price could rise indefinitely, though you can exit anytime to limit losses. If dividends are paid while you have the stock borrowed, you must pay them to the lender. The same goes for interest on borrowed bonds.

When you borrow shares, you or your broker might pay a rebate fee with interest to the lender. It's tough for individual investors like you to get these rebates; you need a large trading account balance. Typically, big institutions, market makers, and broker/dealers benefit from them.

Short Sale Rebate Fee

As a short seller borrowing shares to deliver, you pay a rebate fee based on the sale amount and share availability. If shares are hard to borrow, the fee goes up. Sometimes, your brokerage might force you to buy the securities back before settlement—a forced buy-in—if they think shares won't be available.

Always check with your broker on the rebate fee for a stock before shorting; if it's too high, it might not be worth it.

How Margin Accounts Are Used in Short Stock Rebates

Regulation T from the Federal Reserve Board mandates that all short sales go through a margin account. You must deposit 150% of the short sale value—for a $10,000 short, that's $15,000. This protects the brokerage from your potential unlimited losses.

If the security price rises, you'll need to deposit more to cover larger losses. If it keeps rising and you can't add funds, your position gets liquidated. You're liable for all losses, even beyond your account balance.

Take this example: If you short 100 shares at $50, you're short $5,000 and need $7,500 in your account. If the stock drops, you're fine. But if it jumps to $80, exiting costs $8,000, meaning a $3,000 loss deducted from your balance.

Example of a Rebate

Suppose you borrow $10,000 worth of stock ABC to short it, agreeing to a 5% simple interest rate. By settlement, your account needs to be at $10,500. You transfer $500 to the lender on that date.