A brokerage account that allows investors to borrow money to buy securities
A margin account is a type of brokerage account that allows you to borrow against the assets in your account.
Borrowing the assets in your account is known as a margin loan and may have a lower interest rate than unsecured loans.
If the equity in your margin account drops too low, the brokerage could sell your investments without warning.
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When you open a brokerage account, you may have the option of opening a cash account or a margin account. Both types of accounts allow you to buy and sell stocks and other investments. But margin accounts also allow you to borrow money from the assets in your account.
These loans can be tempting, especially when they offer a low interest rate and don’t require a credit check. However, you want to understand all the risks you can take if you take a margin loan.
How do margin accounts work?
A margin account is a brokerage account that gives you the option of using your account as collateral to borrow money.
âThink of it as an investment account with a line of credit associated with it,â says Brent Weiss, Certified Financial Planner and Co-Founder of Facet Wealth. “Similar to how a home can have a home equity line of credit.”
You can be set up with a default margin account, or switch from a cash account to a margin account if you have at least met the minimum balance requirement for the margin account.
Once you’ve opened a margin account, your account balance can determine how much you can borrow. However, some investments, such as stocks that trade over-the-counter (OTC) rather than on the stock exchange, may not be valued, meaning you cannot borrow against them.
âAs long as you have enough taxable investments, margin loans can be an easy way to access cash at low interest rates,â Weiss explains. “Some investors want to increase their purchasing power and even speculate on certain investments, and a margin loan is an easy way to do this, but they should be aware of the additional risk associated with such a decision.”
How much do margin loans cost?
Margin account loans are a little different from a loan or line of credit from other lenders. And, in some situations, it can be much easier and less expensive than other loan options.
“It is free to set up a margin loan, which is not the case when you take out a mortgage, where you have loan fees, sometimes have to pay points, and often have to pay for a home loan appraisal. house, âsays Erin Scannell. , private wealth advisor at Ameriprise Financial. “None of these costs exist with a margin loan.”
Margin loans generally don’t require a credit check or upfront fees, and they can have lower interest rates than unsecured credit cards or personal loans. However, rates are often variable – based on a broker’s base rate plus a margin rate that depends on your outstanding balance.
There is also no fixed repayment period with margin loans, and some borrowers will wait to repay the loan until they sell the assets they bought with the money. However, the interest will continue to accrue as long as the loan is outstanding.
What are the advantages and disadvantages of a margin account?
- Easy to qualify. Loan limits can be determined by your marginal asset balance rather than your creditworthiness.
- Quick financing. There won’t be a big application process once your Margin Account is opened. âIn an emergency, you can often get the money within 72 hours,â says Scannell.
- Low rates compared to unsecured loans. Since these are secured loans, you may receive a lower interest rate than other types of current credit accounts.
- Increase potential returns. Buying investments with borrowed money can increase your overall returns.
- Avoid having to sell when the markets are down. Long-term investors whose investments are not performing well, but need cash, might not want to sell while the markets are down.
- Postpone taxable events. âBorrowing on your investments can help you avoid selling an asset and creating a taxable event,â Weiss points out. If you sold your investments for a gain, you may have to pay capital gains taxes on your profits.
- Increased risk. There is a risk that you may not be able to repay the loan, especially if your investments (or the investments you buy with the loan) fall. You could even lose more than what you initially invested.
- You may be forced to sell your investments. “If the loan balance exceeds a certain threshold, the custodian can either force an account holder to deposit more funds or sell their investments to cover the loan, âWeiss warns. If this happens, you may not have a say in when or what investments are sold.
- Interest accrues and rates are subject to change. Interest will continue to accrue on your loan as long as it is unpaid, and the rate may change at any time.
- Debt could be sent to collections. If your assets can’t cover your debt and you don’t pay off the loan, it could go into collection (which could hurt your credit). You could even be sued and have your salary or bank account seized.
What is a margin call?
Margin accounts have a “maintenance requirement” which is the amount of equity you need to have in your margin account. At a minimum, you may need at least 50% equity when taking out a margin loan and 25% outstanding equity based on the current value of your account. Although the “house rules” of some brokers may require a higher level of maintenance.
“If the loan balance exceeds this limit due to too much borrowing or underperforming investments, the custodian may require the account holder to provide additional funds to cover the deficit – also called a margin call,” explains Weiss.
There are different types of margin calls, but as a simple example, let’s say you have a margin account with US $ 10,000 (AU $ 13,693) invested in securities and you take out a margin loan of 5 US $ 000 (AU $ 6,846). ).
If the total value of your account drops to US $ 7,500 (AU $ 10,270), you only have 25% equity (US $ 7,500 (AU $ 10,270) minus the US $ 5,000 loan ( AU $ 6,846) is $ 2,500 USD (AU $ 3,423). There could be a margin call if the account goes down.
âAt this point, the account owner can either deposit money into the account or sell an investment to pay off the loan,â Weiss explains. âIf the margin call is not met on time, the custodian can force a sale on the account without notifying the account holder. “
Margin accounts vs cash accounts
Cash accounts and margin accounts are two types of brokerage accounts, and you can use either of them to trade securities. Even if you have a margin account, you don’t need to take out a margin loan.
|Margin account||Cash account|
The financial report
Margin accounts allow you to use the money in your brokerage accounts as collateral for a line of credit. It can be relatively quick and easy to take out a margin loan, and the loan may have a lower interest rate than regular unsecured credit accounts.
However, using margin loans to invest can increase your returns and losses. And you will be at the mercy of the market and your brokerage. If the value of your account goes down, you may only have a few days to add more money to your account or pay off part of your margin loan. Otherwise, the brokerage could sell your investments – potentially at a less than ideal time.
âWhen used as part of an overall plan, they can be useful tools, but they should always be seen as one facet of a much larger financial picture,â Weiss says. âUse a lot of caution if you plan to use a margin loan to purchase additional investments. “