Margin: Borrowing Money to Pay for Stocks (2022)

"Margin" is borrowing money from your broker to buy a stock and using your investment as collateral. Investors generally use margin to increase their purchasing power so that they can own more stock without fully paying for it. But margin exposes investors to the potential for higher losses. Here's what you need to know about margin.

Understand How Margin Works

Let's say you buy a stock for $50 and the price of the stock rises to $75. If you bought the stock in a cash account and paid for it in full, you'll earn a 50 percent return on your investment. But if you bought the stock on margin – paying $25 in cash and borrowing $25 from your broker – you'll earn a 100 percent return on the money you invested. Of course, you'll still owe your firm $25 plus interest.

The downside to using margin is that if the stock price decreases, substantial losses can mount quickly. For example, let's say the stock you bought for $50 falls to $25. If you fully paid for the stock, you'll lose 50 percent of your money. But if you bought on margin, you'll lose 100 percent, and you still must come up with the interest you owe on the loan.

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In volatile markets, investors who put up an initial margin payment for a stock may, from time to time, be required to provide additional cash if the price of the stock falls. Some investors have been shocked to find out that the brokerage firm has the right to sell their securities that were bought on margin – without any notification and potentially at a substantial loss to the investor. If your broker sells your stock after the price has plummeted, then you've lost out on the chance to recoup your losses if the market bounces back.

Recognize the Risks

Margin accounts can be very risky and they are not suitable for everyone. Before opening a margin account, you should fully understand that:

  • You can lose more money than you have invested;
  • You may have to deposit additional cash or securities in your account on short notice to cover market losses;
  • You may be forced to sell some or all of your securities when falling stock prices reduce the value of your securities; and
  • Your brokerage firm may sell some or all of your securities without consulting you to pay off the loan it made to you.

You can protect yourself by knowing how a margin account works and what happens if the price of the stock purchased on margin declines. Know that your firm charges you interest for borrowing money and how that will affect the total return on your investments. Be sure to ask your broker whether it makes sense for you to trade on margin in light of your financial resources, investment objectives, and tolerance for risk.

Read Your Margin Agreement

To open a margin account, your broker is required to obtain your signature. The agreement may be part of your account opening agreement or may be a separate agreement. The margin agreement states that you must abide by the rules of the Federal Reserve Board, the New York Stock Exchange, the National Association of Securities Dealers, Inc., and the firm where you have set up your margin account. Be sure to carefully review the agreement before you sign it.

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As with most loans, the margin agreement explains the terms and conditions of the margin account. The agreement describes how the interest on the loan is calculated, how you are responsible for repaying the loan, and how the securities you purchase serve as collateral for the loan. Carefully review the agreement to determine what notice, if any, your firm must give you before selling your securities to collect the money you have borrowed.

Know the Margin Rules

The Federal Reserve Board and many self-regulatory organizations (SROs), such as the NYSE and FINRA, have rules that govern margin trading. Brokerage firms can establish their own requirements as long as they are at least as restrictive as the Federal Reserve Board and SRO rules. Here are some of the key rules you should know:

Before You Trade – Minimum Margin

Before trading on margin, FINRA, for example, requires you to deposit with your brokerage firm a minimum of $2,000 or 100 percent of the purchase price, whichever is less. This is known as the "minimum margin." Some firms may require you to deposit more than $2,000.

Amount You Can Borrow – Initial Margin

According to Regulation T of the Federal Reserve Board, you may borrow up to 50 percent of the purchase price of securities that can be purchased on margin. This is known as the "initial margin." Some firms require you to deposit more than 50 percent of the purchase price. Also be aware that not all securities can be purchased on margin.

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Amount You Need After You Trade – Maintenance Margin

After you buy stock on margin, FINRA requires you to keep a minimum amount of equity in your margin account. The equity in your account is the value of your securities less how much you owe to your brokerage firm. The rules require you to have at least 25 percent of the total market value of the securities in your margin account at all times. The 25 percent is called the "maintenance requirement." In fact, many brokerage firms have higher maintenance requirements, typically between 30 to 40 percent, and sometimes higher depending on the type of stock purchased.

Here's an example of how maintenance requirements work. Let's say you purchase $16,000 worth of securities by borrowing $8,000 from your firm and paying $8,000 in cash or securities. If the market value of the securities drops to $12,000, the equity in your account will fall to $4,000 ($12,000 - $8,000 = $4,000). If your firm has a 25 percent maintenance requirement, you must have $3,000 in equity in your account (25 percent of $12,000 = $3,000). In this case, you do have enough equity because the $4,000 in equity in your account is greater than the $3,000 maintenance requirement.

But if your firm has a maintenance requirement of 40 percent, you would not have enough equity. The firm would require you to have $4,800 in equity (40 percent of $12,000 = $4,800). Your $4,000 in equity is less than the firm's $4,800 maintenance requirement. As a result, the firm may issue you a "margin call," since the equity in your account has fallen $800 below the firm's maintenance requirement.

Understand Margin Calls – You Can Lose Your Money Fast and With No Notice

If your account falls below the firm's maintenance requirement, your firm generally will make a margin call to ask you to deposit more cash or securities into your account. If you are unable to meet the margin call, your firm will sell your securities to increase the equity in your account up to or above the firm's maintenance requirement.

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Always remember that your broker may not be required to make a margin call or otherwise tell you that your account has fallen below the firm's maintenance requirement. Your broker may be able to sell your securities at any time without consulting you first. Under most margin agreements, even if your firm offers to give you time to increase the equity in your account, it can sell your securities without waiting for you to meet the margin call.

Ask Yourself These Key Questions

  • Do you know that margin accounts involve a great deal more risk than cash accounts where you fully pay for the securities you purchase? Are you aware you may lose more than the amount of money you initially invested when buying on margin? Can you afford to lose more money than the amount you have invested?

  • Did you take the time to read the margin agreement? Did you ask your broker questions about how a margin account works and whether it's appropriate for you to trade on margin? Did your broker explain the terms and conditions of the margin agreement?

  • Are you aware of the costs you will be charged on money you borrow from your firm and how these costs affect your overall return?

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  • Are you aware that your brokerage firm can sell your securities without notice to you when you don't have sufficient equity in your margin account?

Learn More About Margin Trading

For more information, visit the website of FINRA and read Investing with Borrowed Funds: No "Margin" for Error, which links to other articles, statistics, and resources on margin trading.

Margin: Borrowing Money to Pay for Stocks (1)

FAQs

What happens if you get margin called and can't pay? ›

A failure to promptly meet these demands, known as a margin call, can result in the broker selling off the investor's positions without warning as well as charging any applicable commissions, fees, and interest.

What happens when you borrow on margin? ›

As with any loan, when you buy securities on margin you have to pay back the money you borrow plus interest, which varies by brokerage firm and the amount of the loan. Margin interest rates are typically lower than those on credit cards and unsecured personal loans.

What is borrowing stocks of margin? ›

Simply put, borrowing on margin means taking an interest bearing loan secured by securities you own in your brokerage account (the securities are pledged as collateral for the loan).

What does a margin requirement of 100% mean? ›

As a result, if you borrow the maximum amount for a position with higher margin requirements and the position decreases in value, you may immediately receive a margin call. Positions with a 100% requirement cannot be purchased on margin.

How long do you have to satisfy a margin call? ›

Many margin investors are familiar with the "routine" margin call, where the broker asks for additional funds when the equity in the customer's account declines below certain required levels. Normally, the broker will allow from two to five days to meet the call.

How long can you hold stock on margin? ›

Be aware that some brokerages require you to deposit more than 50% of the purchase price. You can keep your loan as long as you want, provided you fulfill your obligations. First, when you sell the stock in a margin account, the proceeds go to your broker against the repayment of the loan until it is fully paid.

Is using margin a good idea? ›

While margin loans can be useful and convenient, they are by no means risk free. Margin borrowing comes with all the hazards that accompany any type of debt — including interest payments and reduced flexibility for future income. The primary dangers of trading on margin are leverage risk and margin call risk.

Can you pay off margin loan without selling? ›

With a margin account, you can access cash without having to sell your investments. Your brokerage can give you instant access to funds, which you can pay back at your convenience by either depositing cash or selling securities.

What is it called when you borrow money to buy stocks? ›

"To margin" or "buying on margin" means to use money borrowed from a broker to purchase securities. You must have a margin account to do so, rather than a standard brokerage account.

What happens when you use margin to buy stocks? ›

Buying stocks on margin means investors are borrowing money from their broker to purchase stock shares. The margin loan increases buying power, allowing investors to buy more shares than they would have been able to, using only their cash balance.

What does it mean to buy stock on margin? ›

Buying on margin involves getting a loan from your brokerage and using the money from the loan to invest in more securities than you can buy with your available cash. Through margin buying, investors can amplify their returns — but only if their investments outperform the cost of the loan itself.

How much margin is in the stock market? ›

Overview. Margin debt is money that investors borrow in order to invest in stocks. As of August 31, 2022 (the latest data available), total US margin debt was $688 billion, which represents a decrease of $299 billion year-over-year.

How much margin is safe? ›

When possible, try not to use more than 10% of your asset value as a margin and draw a line at 30%. It is also a great idea to use brokers like TD Ameritrade that have cheap margin interest rates. Remember, the margin interest compounds as long as you keep the margin open.

What is the minimum margin requirement? ›

FINRA Rule 4210 requires that you maintain a minimum of 25% equity in your margin account at all times. Most brokerage firms maintain margin requirements that meet or, in many cases, exceed those set forth by regulators.

What is margin limit? ›

The margin limit is the amount of money brokers allow you to borrow. The margin limit is a percentage of the total value of securities in your account. For example, if your account has ₹1 lakh worth of securities, and your broker allows a 50% margin limit, he will lend ₹50,000 to buy securities.

How do you satisfy a margin call? ›

You can satisfy a margin call in 1 of 4 ways:
  1. Sell securities in your margin account. ...
  2. Send money to your account by electronic bank transfer, wire, or check by overnight mail.
  3. Sell or exchange Vanguard mutual funds from an account held in your name and use the proceeds to purchase shares of your settlement fund.

What happens after margin call? ›

A margin call is usually an indicator that securities held in the margin account have decreased in value. When a margin call occurs, the investor must choose to either deposit additional funds or marginable securities in the account or sell some of the assets held in their account.

Can you hold margin overnight? ›

Tip #2 – Don't Hold Positions Overnight On Margin

For new traders or traders with smaller accounts, holding a position overnight on margin is just too risky and should be avoided at all cost. Stocks gap down on unexpected news everyday and if you are fully loaded on margin that loss will be greatly magnified.

What is a margin loan and how does it work? ›

A margin loan allows you to borrow against the value of securities you already own. It's an interest-bearing loan that can be used to gain access to funds for a variety of reasons that cover both investment and non-investment needs.

Can you withdraw margin money? ›

Margin can also be used to make cash withdrawals against the value of the account in the form of a short-term loan. For investors seeking to leverage their positions, a margin account can be very useful and cost-effective.

How much can I borrow margin loan? ›

Most margin lending providers allow an LVR of up to around 70%. This means that if you already had investments valued at $30,000 (to use as security) you could borrow up to $70,000 to buy additional investments using a margin loan. The loan is then secured over the whole portfolio.

How do you pay margin balance? ›

You can reduce or pay off your debit balance (which includes margin interest accrued) by depositing cash into your account or by liquidating securities. The proceeds from the liquidation will be applied to your debit balance.

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