A margin account is an investment account in which a broker essentially lends the account holder cash to purchase securities. An investor with a margin account can usually borrow up to half of the total purchase price of marginable investments. The percentage amount may vary between different investments. Each brokerage firm has the right to define which types of investments among stocks, bonds, ETFs or mutual funds can be purchased on margin.
How a Margin Account Works
A margin account – based on the equity in an investor's account – works essentially in the same way as a bank willing to loan money on home equity. Buying on margin involves an investor's brokerage firm lending the investor money against the value of cash or investment assets currently in the margin trading account. The amount borrowed is referred to as a margin loan that the investor can use to purchase additional investments.
For example, if an investor has $10,000 in a margin trading account, they could potentially purchase up to $20,000 of stock by borrowing the remainder of the required purchase funds from their broker in the form of a margin loan. An investor can borrow against cash in the account or against marginable stocks or debt securities, such as bonds, in the account.
Buying on margin provides investors the ability to leverage their investments for building larger investment portfolios than they otherwise could maintain using only their available cash. The leverage magnifies any profits realized from the investment, but it also magnifies losses in the same way. Additionally, an investor must pay back whatever margin loan they have received from their broker along with the interest that is charged on the loan. Monthly interest charges accrue against margin loans.
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What Is a Margin Call?
Trading on margin makes investors subject to margin calls. If the value of the cash and investments in the investor's margin account drops below a certain level, then the investor receives a margin call from their brokerage firm.
A margin call requires the investor to deposit additional cash or marginable investments to bring the value of the account up to the minimum required level. Failure to do so gives the brokerage the right to liquidate a sufficient amount of securities to meet the margin call.