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Although investors can use cash to purchase investments, in some cases qualified investors may obtain a margin loan from their brokerage, which enables them to place bigger trades than they can cover with cash alone (i.e., leverage).
Similar to any other type of loan, investors must apply for a margin account with their brokerage and be approved before they can borrow funds, which must be repaid with interest. Margin loans are governed by strict rules, because the use of leverage increases potential gains, but also the risk of loss.
Key Points
• A margin loan is similar to a line of credit from a brokerage that enables qualified investors to borrow funds to purchase securities.
• A margin loan is a type of leverage that effectively increases the investor’s buying power.
• To obtain a margin loan, investors must be approved for a margin account, which is subject to strict regulatory and brokerage-specific rules.
• Margin loans require investors to maintain a minimum amount of collateral, i.e., maintenance margin, to ensure they can cover potential losses.
• While margin trading offers the potential for increased profits, it also introduces significant risk, as losses are amplified and must still be repaid with interest.
What Is a Margin Loan?
A margin loan is similar to obtaining a line of credit from a brokerage that enables you to borrow up to 50% of the securities you want to purchase when investing online or via other means. Having a margin account by definition enables you to trade on margin, which is a type of leverage.
Most brokerages offer qualified investors the option of adding a margin account to an ordinary taxable account. Because margin trading can increase gains as well as losses, it’s considered a high-risk strategy.
Having the flexibility to buy securities on margin gives many traders the ability to take positions they might not have been able to afford otherwise. In fact, margin loans are a cornerstone to putting together effective day trading strategies, for advanced investors.
Understanding Margin Loans
Understanding margin can be tricky, as margin accounts and therefore margin loans are highly regulated.
In most cases, you can borrow up to 50% of the securities you plan to purchase and pay for the rest with cash. So, if you have $3,000 in cash or equities in your margin account, you can take a margin loan of $3,000 to buy up to $6,000 worth of securities on margin.
In order to be able to continue taking out margin loans, you’re required to keep a minimum amount of cash in the account, known as maintenance margin. FINRA (the Financial Industry Regulatory Authority) requires a maintenance margin level of 25% of the total value of the securities in the account. That’s a baseline, but a brokerage may have its own requirements.
Recommended: What Is Leveraged Trading?
How Margin Loans Work
A margin loan is more or less like any other loan. To get one, you’ll need to apply and qualify for margin on your brokerage account.
Margin Accounts and How They Work
Like other forms of lending, margin loans have strict criteria. These accounts are governed by industry regulations as well as individual brokerage rules, so be sure to understand how your margin account works.
Each brokerage has different rules and eligibility requirements, and FINRA, for example, also requires you to deposit a minimum of $2,000 or 50% of the security’s purchase price, whichever is larger. This is the “initial margin.” Some firms may require you to deposit more than $2,000.
If you’re approved for a margin account, you’re able to trade using a margin loan — up to a certain amount. According to Regulation T of the Federal Reserve Board, you may borrow up to 50% of the purchase price of securities that can be purchased on margin.
As noted, those interested in self-directed investing should know that 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. Only those deemed “marginable” can be traded on margin.
If you have $5,000 in your brokerage account, and you want to buy stock from Company A, which is valued at $50 per share, you could buy 100 shares in an ordinary taxable account. But with a margin loan you could buy 50% more than your cash balance: 200 shares instead of 100, for a total value of $10,000.
Increase your buying power with a margin loan from SoFi.
Borrow against your current investments at just 4.75% to 9.50%* and start margin trading.
*For full margin details, see terms.
How Margin Interest Works
The other important thing to remember about margin loans is that they are subject to interest charges, depending on the rate your broker charges. Most brokerages will charge interest by the day and add the charges to your account monthly. So, if you have cash or can sell securities and pay your balance off before interest accrues, it’s possible.
Margin Loan Pros and Cons
Marginal loans can be highly useful for traders and investors. But like almost any financial instrument, margin loans have their pros and cons.
The biggest upside of margin is that it can open up a new swath of investing choices for traders. That means increasing their buying power, and allowing them to buy securities that may have otherwise been too expensive. This can increase potential profitability, too.
Conversely, traders who aren’t careful can’t quickly find themselves in debt if one of their trades backfires.
There are also interest charges to consider, as discussed. And if things really go sideways, some traders may experience a margin call, which is when your brokerage sells your assets without warning to settle up or get your account balance back within its requirements.
Here’s a quick rundown:
Margin Loans: Pros & Cons
| Pros | Cons |
|---|---|
| Increased trading capacity | Traders can accumulate debt |
| Traders can buy pricier securities | Interest charges |
| Increased potential gains | Potential margin calls |
Typical Margin Loan Rates
Margin loan rates, or, the interest rate charged by a brokerage for using margin, vary. Brokerages make the information available to traders and investors, so finding what types of margin loan rates you’re subjected to usually just requires a little research (or a call to your broker).
As mentioned, a brokerage will probably charge different interest rates depending on your overall margin balance, and how much you’ve borrowed. Lower balances are typically charged higher interest rates.
Here are some hypothetical examples: Let’s say Brokerage ABC’s margin interest rates vary between 4% and 8%, depending on the trader’s balance. Traders using up to $24,999 in margin will be subject to the highest interest rate (8%), whereas traders with more than $1 million in margin debit are subject to the 4% rate.
Brokerage B, however, has a different scale, with traders in margin debt up to $24,999 subject to 8.5% interest, and those with balances between $500,000 and $999,999 subject to 6.5%.
So, while brokerages do vary in what they charge for margin loan rates, they tend to be similar. To know your exact rate, contact your brokerage, or look up the current rate schedule on the company’s website.
The Takeaway
Margin loans are similar to other types of credit, but are typically used for the purpose of buying stocks or other securities. Once you’ve applied for and been approved for a margin account, which is akin to adding a line of credit to your existing brokerage account, you’ll have the flexibility to buy more investments than if you were relying only on cash.
That said, you’re on the hook for repaying the money you’ve borrowed, with interest. If you’ve made a profitable investment, this shouldn’t be a problem. But if your investment loses money, you would still owe the full amount you’d borrowed to buy the stock, plus interest.
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
FAQ
Can you withdraw a margin loan?
Yes, it’s possible to withdraw a margin loan, although the specifics will depend on an individual brokerage, as will any applicable interest charges.
Are margin loans a good idea?
Margin loans can be useful for many investors and traders, and whether or not they’re a good idea will depend on the specific individual considering taking one out. They do expose investors to a higher risk of loss, but the potential for gains, too.
How do I pay back my margin loan?
The simplest ways to pay back margin loans are to either deposit cash into your brokerage account to get the balance back to zero, or to sell holdings that will result in a positive or neutral balance.
How much collateral is required for a margin loan?
The collateral required to take out a margin loan depends on a specific brokerage, but it’s not uncommon for brokerages to require somewhere between 30%, 40%, or 50%.
What happens if you can’t pay back a margin loan?
If you can’t pay back a margin loan, the brokerage will give you a short time (about five business days) to bring up your balance. Failing that, it could end up liquidating securities in your portfolio in order to cover the loan amount.
Photo credit: iStock/Sergey Nazarov
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Trading securities on margin loans involves high risk and costs and is not suitable for all investors. It is possible to lose more than your initial investment when using margin. Please see more details at https://www.sofi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf
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