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Margin accounts

How borrowing from a broker to buy securities works, what Regulation T and the 25 percent maintenance rule require, and what a margin call can lead to.

What it means to buy on margin

The SEC's publication Margin: Borrowing Money to Pay for Stocks defines margin as borrowing money from your broker to buy a stock and using your investment as collateral. The same publication works a simple example: a stock bought at $50 that later trades at $75. Paid in full, that is a 50 percent return on the cash put up. Bought with $25 of cash and $25 of broker loan, the same price move is a 100 percent return on the cash, with the $25 loan plus interest still due. The mirror image is the risk: if the stock falls to $25, a cash buyer has lost 50 percent, while the margin buyer has lost the entire $25 of cash and still owes interest.

The publication lists consequences that surprise some account holders. An investor can lose more money than was invested. The firm may require additional cash or securities on short notice. The firm may sell some or all of the securities in the account without consulting the customer, to pay off the loan, and it may not have to give notice first. Those points are features of the margin agreement, which the broker is required to have signed before the account is used for margin.

Initial margin and maintenance

Before trading on margin, FINRA requires a deposit of at least $2,000 or 100 percent of the purchase price, whichever is less (the "minimum margin"); a firm may ask for more. For the trade itself, Regulation T of the Federal Reserve Board allows a customer to borrow up to 50 percent of the purchase price of securities that can be bought on margin. That 50 percent is the initial margin. Not every security is margin-eligible, and a firm may require a larger cash share than Regulation T does.

After the purchase, a maintenance requirement applies. The SEC publication says the rules require equity of at least 25 percent of the total market value of the securities in the margin account at all times. Equity here means the value of the securities minus the amount owed to the firm. Many firms set a higher house requirement, often in the 30 to 40 percent range, and sometimes higher for particular stocks. If equity falls below the firm's requirement, the firm may issue a margin call asking for more cash or securities, or it may sell holdings to restore the required equity.

• Margin is a loan from the broker, secured by the securities in the account.
• Regulation T caps the initial loan at 50 percent of the purchase price of margin-eligible securities; firms may be stricter.
• A maintenance requirement (at least 25 percent under the rule the SEC describes, often higher at the firm) can trigger a margin call or a sale of securities.

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