Margin Accounts Explained: Buying on Margin, Margin Calls and the Risks

A margin account lets you borrow money from your broker to buy securities, using the investments in your account as collateral. That borrowing is called leverage. It magnifies both gains and losses, and it comes with rules that can force your positions to be sold at the worst possible time.

Here is how margin works in the US, which regulators set the rules, and what can go wrong. It is an explainer, not a recommendation to use margin.

Cash accounts vs margin accounts

When you open a brokerage account, you typically choose between two types:

• Cash account. You buy only with money you have deposited. You cannot borrow, and you cannot lose more than you put in.
• Margin account. You sign a margin agreement and can borrow against eligible securities. The account can also be used for short selling and some options strategies.

Many brokers ask during sign-up or switch on margin by default. The margin agreement is a loan contract, and it gives the broker significant rights over your account.

The rules: who sets them

Margin in the US is governed by several layers of rules.

House requirements matter most in practice. Many brokers set maintenance levels above 25%, set higher requirements for volatile or concentrated positions, and may not let you buy some securities on margin at all. Brokers can raise these requirements without advance notice, which often happens during market turmoil.

How buying on margin works: a worked example

The numbers below are illustrative, not a forecast.

Suppose you want to buy $10,000 of a stock. You put in $5,000 of your own money and borrow $5,000 from your broker, which meets the 50% initial margin requirement.

• Market value: $10,000
• Loan: $5,000
• Your equity: $5,000 (market value minus loan)

If the stock rises 20%, the position is worth $12,000. You still owe $5,000, so your equity is $7,000. That is a 40% gain on your $5,000, before interest and costs.

If the stock falls 20%, the position is worth $8,000. You still owe $5,000, so your equity is $3,000. That is a 40% loss on your money.

A 20% move in the stock became a 40% move in your equity. That is what leverage does, and it works in both directions.

What triggers a margin call

A margin call happens when your equity falls below the maintenance requirement.

Using the example above with a 25% maintenance requirement, the trigger arrives when equity is 25% of the market value. Since the loan stays at $5,000, that happens when the position falls to about $6,667, a drop of roughly a third from the purchase price. With a 30% house requirement, the call arrives sooner, at about $7,143.

When you get a margin call, you generally have three options:

1. Deposit cash to raise your equity.
2. Deposit other marginable securities as extra collateral.
3. Sell positions to pay down the loan.

The important detail is in the margin agreement: the broker is not required to wait for you. If markets move fast, the firm can sell securities in your account without contacting you, choose which positions to sell, and does not have to give you time to meet the call. You are not entitled to an extension.

The costs of borrowing

Margin is a loan, and you pay interest on it every day the balance is outstanding.

• Rates vary widely between brokers and are usually tiered, with lower rates on bigger balances. They tend to move with benchmark interest rates. Your broker publishes its current schedule.
• Interest is charged whether your investments go up or down. A position that only matches the market can still lose money once interest is counted.
• Interest compounds if it is added to the loan balance.

For investors who itemize deductions, investment interest expense may be deductible within limits set by the IRS. The rules have conditions, so check IRS guidance or ask a tax professional.

The main risks of margin

• Magnified losses. As the example shows, a modest drop in a stock can wipe out a large share of your equity.
• Losses beyond your deposit. A sharp gap down, such as overnight after bad earnings news, can push the position below the loan balance. You owe the shortfall.
• Forced selling at the bottom. Margin calls tend to cluster in sell-offs, which can turn a temporary decline into a permanent loss.
• Moving requirements. House requirements can tighten during volatility, triggering calls even when prices haven't moved much.
• Concentration risk. Borrowing against one or two stocks leaves less room for error than a diversified account.

Note that SIPC coverage protects your account if a broker fails, not against market losses or margin calls. Our SIPC explainer covers what is and isn't protected.

Other uses of margin

Margin isn't only for buying more stock. A margin account is also needed for:

• Short selling. You borrow shares to sell, hoping to buy them back cheaper. Losses on a short position are theoretically unlimited.
• Some options strategies. Brokers set their own approval levels and requirements.
• Borrowing against a portfolio. Some investors draw on a margin loan for cash needs. The same margin call rules apply, so a market fall can force sales.

Frequent traders should also be aware of FINRA's pattern day trading rules for margin accounts. Check FINRA and your broker for current requirements.

Questions to ask before using margin

If you are weighing margin, these questions frame the decision:

• What is my broker's maintenance requirement for the specific securities I hold, and how often can it change?
• What is the current margin rate at my balance level, and how does it compare with other brokers?
• How far could my positions fall before a margin call? Work out the price, not just the percentage.
• Do I have cash available to meet a call without selling at a loss?
• Would I be comfortable if the broker sold my holdings without asking first?

Margin can add flexibility, but it adds a loan, interest costs and the possibility of forced sales to an investment plan. FINRA and the SEC's Investor.gov both publish plain-language investor guides on margin, and your broker's margin agreement and disclosures set out the exact terms that apply to your account.