It is a loan which the investment broker extends to the investor. Through the investment brokers it is secured by investment securities held in the investors account. Margin loan rates are based on prime rate or other interest index and then a margin is added to the rate and varies depending on the size of the investors account. Margin loans are not like other loan which needs to be paid back; in fact it is like a rotating credit which is secured by your investment securities, which can be paid as per your convenience. If you find any difficulties in paying back, you can also sell your security positions and pay back.
The Investment broker will permit you to borrow, or margin, up to 50% of your Stocks value or any securities you are buying or value of your own account at any one time. There is also cushion of minimum investment equity value of at least 30% of your holdings. In case if your value of investment holdings drifts below 30%, a margin call will always be issued by your broker on your behalf. The said drift can happen due to 2 main reasons –
- The value of the investment securities drifts drastically
- The Investors withdraw cash
Sometime both the reason may combine and lead to drifts. Thus traditional investors usually avoid margin loans, and most of the investors will keep the loan balances at a level that’s well below 50% of the account value.
Don’t ever use the Margin call as first option. Always use the Margin calls on the mower end of the borrowing limits. Instead of using 50 % of your investment which leads to margin call, go for 10-20%. Also do consider the securities portfolios; it is safe to go with the investments such as bonds and dividend paying etc. which are less likely to fall flatter and results in Margin Call.