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A margin account is a type of brokerage account that lets you use the funds in your account as collateral for a loan. Many people take out margin loans to purchase more stocks or other investments. Leveraging your funds (or borrowing to invest) can increase returns and losses, making it a risky proposition. But you can also use a margin loan as an alternative to other types of loans. Here's what to know.
How a Margin Account Works
A margin account works like other types of non-margin (or "cash") brokerage accounts, but there's a line of credit attached to your account.
Unlike a personal line of credit or traditional loan, your income, credit and debt-to-income ratio don't impact your eligibility and borrowing limit. There also may be no closing costs or fees that are commonly associated with a home equity line of credit. And you can take out multiple margin loans without having to reapply.
When you borrow against your margin account's credit line, your borrowing limit depends on the cash and investments in your account. However, brokers might not consider certain investments, such as stocks with a low share price, to be "marginable," meaning you can't use them as collateral.
Once you take out a margin loan, interest on the loan can start to accrue daily. The interest rate could depend on your total loan amount—with higher loans often resulting in a lower rate—and may change without notice. While you generally don't have to make regular payments, you will have to repay the loan and accrued interest.
The specific requirements to open and use a margin account can vary depending on the brokerage company, but generally include the following:
- You need at least $2,000 in your account when you first start.
- If you're using a margin loan to buy investments, you also may be limited to initially borrowing half of the purchase price.
For example, you might have a margin account with $3,000 in cash and feel strongly about a stock. Instead of buying $3,000 in stock, you take out a margin loan for an additional $3,000 and invest $6,000 in total.
You could also use margin loans for non-investment purposes. For example, you might have a lot of stocks that you don't want to sell because that would result in paying capital gains taxes on your profits. If you need a short-term loan, getting a margin loan might be a fast and relatively inexpensive option that lets you stay invested.
Pros and Cons of Margin Accounts
Margin accounts can be helpful and versatile tools for investors, but consider the pros and cons before taking out a margin loan.
Pros
- Doesn't depend on your credit: Eligibility, borrowing limits and interest rates primarily depend on the broker and the margin loan amount.
- Relatively low interest rates: Brokers may charge you much lower interest than you'd pay on a credit card. Your rate may be closer to what you might receive if you have good credit and get an unsecured personal loan.
- Few fees: You might not have to pay any fees to open or use your margin account.
- You don't have to sell your investments: Unlike selling investments, borrowing and repaying a margin loan generally isn't a taxable event.
- No minimum payments: You don't necessarily have to stick to a regular repayment schedule.
Cons
- Can magnify investment losses: If you use a margin loan to buy investments that decrease in value, your losses will be greater than if you had invested without margin.
- Variable interest rates: The interest rate on your margin loan may increase at any time.
- Margin calls: If you're using investments as collateral and their value drops, you may be subject to a margin call, in which your broker demands you deposit more cash in your account or sell investments. If you don't, the brokerage can sell your investments to increase your cash holdings or repay the margin loan.
Margin Account vs. Cash Account
A cash account is the standard type of brokerage account that you can use to buy and sell investments. Both accounts share some similarities, but there are also a few differences that go beyond the ability to borrow money.
| Margin Accounts vs. Cash Accounts | ||
|---|---|---|
| Margin Account | Cash Account | |
| Primary use | Investing | Investing |
| How you buy investments | Use your money plus money you borrow | Use your money |
| Available with retirement accounts? | Generally no | Yes |
| Allows you to short a stock? | Yes | No |
| Minimum balance requirement | $2,000 to start | May start at $0 |
Learn About Investing Before Opening a Margin Account
While margin accounts can be helpful for investors who want to invest with leverage (in other words, debt) or try more advanced trading strategies, the increased risk that comes from trading on margin shouldn't be ignored. Understanding these risks is important for knowing when to use a margin account and the potential consequences of using your investments as collateral.
If you need to borrow money, you can also look into other types of loans and credit cards that don't share these risks. You can even check your credit score for free with Experian and get matched with offers based on your unique credit profile.