What is 'Margin Debt'
Margin debt is the dollar value of securities purchased on margin within an account, which changes daily as the value of the underlying securities in the margin account changes. To prevent a margin call, or request to raise collateral in the account, the margin debt must remain below a specified percentage level of the total account balance, known as the minimum margin requirement.
BREAKING DOWN 'Margin Debt'Due to the potential volatility of marginable securities, margin debt levels and their rate of change may vary when stock markets and market indexes reach relative peaks.
Margin debt is created when borrowing from a brokerage firm through a margin account when purchasing securities. For example, an investor wants to purchase 2,000 shares of Company A for $10 per share, but he does not have $20,000 available. Because the investor has $10,000 in a margin account, he buys the shares on margin. The $10,000 loan amount is margin debt.
Pros and Cons of Margin Debt
Margin debt may provide an investor with an increased return on investment (ROI). For example, an investor buys 200 shares of stock at $40 each with $4,000 in his margin account. After paying the broker in full, the investor sells the shares for $44 each. Without commissions and interest, the ROI is ($44 - $40) / $20, or 20%. Had the investor conducted the trade with a cash account, the ROI would have been ($44 - $40) / 40, or 10%. Because the available margin debt that may accumulate grows with increasing equity costs, more shares may be purchased for potentially greater profits.
However, creating margin debt when the market goes down may lead to a margin call. The investor has a set time to settle the margin debt. He may end up selling the underlying securities for less than he paid. Also, if a margin call is not settled according to the contract, the brokerage firm may sell the margin debt's underlying securities without informing the investor or sue the investor as to settle the margin debt.
Margin Debt and Stock Market Fluctuations
In February 2016, many investors were buying fewer stocks on margin, not creating as much margin debt. Because the market was declining, investors were reducing their risk of prices dropping for stocks that they may have otherwise purchased in margin accounts. If stock prices for underlying securities in margin accounts dropped too far, the investors would have faced margin calls and most likely would have lost money on their securities.