What is Free Credit Balance?
Free credit balance refers to the cash held in a customer's margin account at a broker-dealer that can withdraw on demand at any time. Free cash balance is calculated as the total uninvested remaining money in a margin account after margin requirements, short sale proceeds, received dividends, and purchase transactions awaiting settlement are taken into consideration. Interest is sometimes paid by brokers on the free credit balance.
- The free credit balance takes into account all transactions and margin requirements and is the amount of capital available for withdrawal.
- Some brokers, but not all, pay interest on free credit balances.
- Free credit balances in the US are regulated by the SEC and FINRA.
Understanding the Free Credit Balance
In a cash account, the credit balance is the amount of money that remains after all purchases, and it is free from withdrawal restrictions. However, within a margin account, the credit balance of the account includes not only the cash remaining in the account, but also proceeds from short sales along with money used to meet margin requirements, and excess margin and buying power. Because the credit balance of a margin account includes both unrestricted amounts and restricted amounts, the free credit balance is created to determine the total amount that can be withdrawn by the account holder.
While not required to by law, some brokers pay interest on funds customers hold in free credit balance accounts. Some brokers offer account holders the option of periodic transfer of funds held in their free credit balance accounts into short-term and highly liquid accounts such as FDIC-insured bank accounts or money market funds. Brokers who offer this option must have a policy in place, and follow it, to receive customers’ authorization, whether oral or written, to make the transfers or otherwise invest the funds held in these accounts.
Regulations Covering Free Credit Balances
Since amounts held in credit balance accounts are customer funds, held by brokers, they are highly regulated. Regulations are designed to prevent broker-dealer misuse of customer funds as well as the loss of the funds in the event a broker becomes insolvent or faces liquidity issues.
The Securities and Exchange Commission (SEC) requires brokers to perform a weekly calculation to determine the amounts of funds payable to or receivable from a customer’s free credit balance account. Financial Industry Regulatory Authority (FINRA), the brokerage industry's self-regulatory organization, requires brokers to inform customers of their account balances by providing written statements once a quarter unless customers opt out of receiving such statements. FINRA also requires brokers to provide it with details of the total amounts they hold as of month end in free credit balances in both margin and cash accounts on a monthly basis.
Examples of Free Credit Balances in Trading Accounts
Assume an investor deposits $10,000 into a margin trading account. Once the funds are deposited, if no trades have been made, the free credit balance is $10,000. This is the amount of capital that can be used for trading or withdrawn.
Assume the trader buys 100 shares of stock for $50. This costs $5,000. Their free credit balance is now $5,000 (excluding commissions).
Cash dividends received for positions will add to the free credit balance. Assume the investor receives $50 in dividends on their position. Their free credit balance is now $5,050.
Interest also may be paid to the investor by the broker on the free credit balance. If this is the case, then interest will be received on the free credit balance which will add to its total.
If the stock was purchased with 50% margin, the trader is required to maintain at least $2,500 of the $5,000 position to fund the trade. In this case, the free credit balance is $7,500 ($10,000 - $2,500), excluding commissions.
The trader is required to pay interest on margin positions. Interest will be deducted from the free credit balance, reducing it over time. As the same time, interest may be paid on the free credit balance, if the broker offers this.
Similar to the no margin account example, dividends received will be added to account balance and will increase the free credit balance.