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Margin Loans: An Alternative to Traditional Loans

In contrast to a traditional loan, a margin loan has many different aspects that can benefit its holder. Essentially, a margin loan allows you to borrow money through your brokerage account against securities you already own.

Investors tend to think margin loans are only taken to leverage an investment portfolio to purchase additional securities, but don't realize this type of loan can be used to fulfill many other financing needs. Some investors may have sizeable wealth, but their money is tied up in less-liquid holdings such as retirement accounts, a home, or business venture. Just as you could borrow money for a car or home purchase, or even daily cash-intensive expenses, you can use a margin loan to satisfy the same needs, with some unique advantages and risks compared to a traditional loan.

Margin Loans: Greater Flexibility, Lower Costs
Once you have been approved for and have opened a margin account, you can typically start borrowing, with no additional application needed. An added benefit of a margin loan is that there is no required principal repayment schedule. Interest must be paid each month on the loan, but when and how you pay off a margin loan is up to you. Interest rates on margin loans at Zions Direct currently range from 1.50% to 2.25%, whereas traditional loan rates can be considerably higher.

An Opportunity for the Less Risk-Averse
Although there can be benefits to a margin loan, there are limitations and risks. The total amount of money you can borrow on margin is 50% of the value of your marginable securities, such as eligible stocks, bonds, and mutual funds. If you had $40,000 of marginable securities in your brokerage account, you could borrow $20,000 to use for any cash need you may have. Equity is the value in your account when the loan is taken into account and is calculated by taking the value of your securities less the loan balance. Our example results in an equity balance of $20,000 as depicted below. 

Since margin loans are backed by securities you own, the changing market value of those securities has a significant impact on your equity balance and thus, the status of your margin loan. If the value of your investments drops below what is called the minimum maintenance margin, or "house requirement", you will have to add funds to your account. Each brokerage will have its own house requirement or the required equity in your account backing the loan.  The Financial Industry Regulatory Authority (FINRA) requires you to have at least 25% of the total market value in your margin account at all times, but many brokerages require a higher minimum.  Zions Direct, for example, has a house requirement of 30%.

Assuming your brokerage firm requires a 30% house requirement, with our example above, your equity could not drop below $12,000 ($40,000*0.30 = $12,000).  If your $40,000 of margined stock decreased in value to $30,000, this is what your situation would look like:

The drop in market value of your securities has caused your equity balance to drop to $10,000, which is below the $12,000 required minimum.  Dropping below your house requirement will result in a margin call. A margin call is issued by your brokerage firm and requires you to put additional securities, or cash, into your account to increase your equity to the required minimum. If you are unable to meet the margin call, your brokerage firm is allowed to sell some or all of your securities in order to meet the requirement.

Margin loans provide a unique opportunity to borrow against the investments in your account to provide cash for a variety of financing needs.  Before borrowing on margin, it is important to understand the risks, maintenance margin requirements, the potential volatility of margined securities, and how a margin call could affect your overall financial situation.

To learn more about margin loans, contact Zions Direct at 800-524-8875 or visit www.zionsdirect.com.