What Is an Excess Margin Deposit?
An excess margin deposit is the collateral held in a margin account that is in excess of the minimum level required to maintain that account's good standing. Margin traders who fail to maintain excess margin deposits may find themselves subject to margin calls.
- In margin trading, the excess margin deposit is the difference between the current value of an account and its minimum maintenance requirement.
- If the excess margin deposit drops below zero, the margin trader may be at risk of a margin call.
- Regulations prescribe minimum standards for the equity levels required in margin accounts. However, individual brokerage firms are free to impose more rigorous standards.
- The Financial Industry Regulatory Authority (FINRA) regulates margin requirements.
- The initial margin minimum is 50% of the trade.
Understanding Excess Margin Deposits
In the United States, Regulation T of the Federal Reserve governs the initial deposits necessary to establish a margin trading account. Similarly, the Financial Industry Regulatory Authority (FINRA) is responsible for regulating margin maintenance requirements, which are the minimum levels of collateral required in margin accounts. The value of collateral in a margin trading account that exceeds these regulatory requirements is known as the account's excess margin deposit.
According to Regulation T, a margin trader is able to borrow up to 50% of the purchase price of a stock, provided that that stock is itself eligible for trading on margin. Some stocks, such as securities with very small market capitalizations, may be barred from margin trading altogether.
This 50% level is known as the initial margin. However, individual brokerage firms have the discretion to adjust this rule provided their own standards are more stringent than those of Regulation T. For example, a broker would be permitted to employ 30% as their initial margin, but they would not be allowed to use a more aggressive standard, such as 70%.
Once a stock has been purchased on margin, FINRA regulations require that the collateral deposited in the margin account does not fall below 25% of the market value of the securities purchased. Here again, brokerage firms have the flexibility to adjust their requirements as long as their standards are more stringent than those required by FINRA, such as 35% instead of 25%.
Example of an Excess Margin Deposit
To illustrate, consider a scenario in which an investor purchases $20,000 worth of securities. To finance the purchase, the investor borrows $10,000 from their brokerage firm using a margin trading account. To support this purchase, the investor deposits an additional $10,000 into the account to act as collateral.
If the market value of the securities falls to $18,000, the equity in the investor's margin account would decline to $8,000 ($18,000 worth of stocks minus the $10,000 loan). If the investor's brokerage firm has a maintenance requirement of 25%, then the investor's account would need to have at least $4,500 of equity in order to remain in good standing (25% of $18,000). Since the $8,000 of equity is greater than the maintenance requirement of $4,500, the investor's margin account is still in good standing.
The excess margin deposit, in this case, is, therefore, $3,500 ($8,000 of equity minus the $4,500 maintenance requirement). Using excess margin comes down to whether the excess margin is something you want to use for an alternate investment opportunity or leave it in the account in case the trade moves against you.
What Is Margin Excess or Deficit?
Margin excess is the amount of funds left over after placing a margin trade. This amount is derived from the amount the brokerage requires as margin, with the excess margin being the amount remaining. So if a margin trade requires $1,000, and your account has $1,200, the margin excess would be $200.
How Do I Calculate Excess Margin?
Excess margin is a simple calculation that occurs once a trade's margin requirements have been met. It can fluctuate based on the price of the security (which affects the amount of margin required). See the above example for a thorough explanation of how to calculate excess margin.
Can You Pay Off Margin Loan Without Selling?
You can, but the brokerage will usually liquidiate all your holdings to cover your margin loan if you are in a margin call, as it is the fastest way for them to recoup their percentage. Although the investor is "forced" into selling at an inopportune time, it may actually be better for them long-term as it lowers the amount owed which in turn lowers the amount of interest accrued while they pay off the margin loan.
Can Margin Trading Put You in Debt?
Margin can absolutely put you in debt and is one of the reasons there is a separate approval process for those requesting margin. Although it is ultimately up to the brokerage how much margin they want to extend to an investor, the investor should be extremely cautious when engaging in trades using margin. Typically, a brokerage will liquidate your account before it goes negative (and you owe them an excess of the principal lost), but in some cases, like when there are massive price swings or a trade is heavily margined and goes south, the brokerage cannot act fast enough to cover the loss. It's important to note that a brokerage charges high-interest rates on margin loans.
Who Pays Initial Margin?
The Federal Reserve Board's Regulation T stipulates that the minimum percentage price of a security that must be covered by cash or collateral when using a margin account is 50%. Individual brokerages can set margin requirements higher than the Fed's requirements (such as 70% or 80%) but they cannot be lower, such as 10%. The initial margin is paid for by the account holder (the investor), not the brokerage.
The Bottom Line
Margin is a commonly used trading tool, but one that should be approached with caution. It's easy to overleverage yourself and if you find yourself in a bad trade, the consequences can be much greater than if you were to invest your principal only.