What is Margin Loan? | Read Meaning, Advantages and How it Works


Margin Loan – Meaning & Definition

A margin loan is a line of credit available that can be used to purchase securities. By opening a margin account, you can purchase more securities than you could with your money alone. To get the loan, you have to use cash deposits or securities as collateral (called margin). However, you must maintain the required margin value; if the balance in your margin account falls below the maintenance limit due to market fluctuations, the broker will initiate a margin call and you may have to deposit more collateral or close your positions.

Key Takeaways

  • Margin loan availability is the amount present in a margin account with which investors can purchase securities.
  • A rise or fall in the value of securities in a margin account creates an impact on margin loan availability.
  • A fall in margin loan availability amount below the margin requirement causes investors to face a margin call.
  • Margin loan has several benefits and risks involved. Understanding these risks helps investors reach their financial goals.

How Margin Loan Availability Works?

Margin loan availability shows the amount present in an existing margin account for use by investors and the amount that can be withdrawn for personal use. If the value of purchased securities changes, margin loan availability will also tend to change. Customers can check the amount left in their margin accounts either for purchasing securities or withdrawals.

There is a direct relationship between the value of purchased securities and margin loan availability. If the value of purchased securities depreciates, so will the margin loan availability. Similarly, if there is a rise in purchased securities value, the margin loan availability will also increase.

However, an investor will face margin calls if the margin loan availability amount is below the margin. This calls for investors to sell off securities and add deposits in margin accounts to restore the margin requirement. Otherwise, the broker can liquidate the investor’s open positions to recover dues, which can lead to massive losses.

Example of Margin Loan Availability

Let us consider a real-life example of margin loan availability. Mrs. Sharma has ₹50,000 in margin account. With a maximum loan-to-value ratio of 70%, Mrs Sharma is capable of borrowing ₹116,000. With ₹50,000 in account, she can invest ₹166,000. If she borrows just ₹50,000, she will have ₹100,000 with her in total for investment.

She is now willing to invest the borrowed ₹50,000 amount, choosing to pay the interest amount beforehand. Mrs. Sharma decides to sell off the shares with the borrowed amount in the next 5 years or so. During this period, if the value of securities increases, it will be possible for her to repay the loan and withdraw the extra amount.

Conversely, in this period, if the value of securities falls below the maintenance limit, she will experience a margin call. To bring back the margin amount in the account, Mrs Sharma would need to sell her shares or utilise more capital.

Margin Loan Pros and Cons

Before opting for a margin account, make sure to understand the benefits and risks associated with a margin loan. Here are the benefits you can avail:

  • Increased Purchasing Capacity: With a margin loan, you can raise your purchasing capacity in the market. This is an ideal time to avail investment opportunities. A margin loan allows you to borrow funds apart from your existing funds to purchase securities.
  • Amplifies Potential Profits: By using leverage, you multiply the maximum profits you can make. When the market moves in your preferred direction, you can make massive profits.
  • Flexibility: Margin loan offers flexibility in using cash as and when needed. Investors can use margin loans instead of selling out securities at unsuitable prices.

Apart from the numerous benefits it provides, there are some risks involved. Thus, it is advisable to look after the risks before choosing a margin loan to reach your desired financial goals.

The following are the risks involved in a margin loan:

  • Volatility: Margin loan responds to market volatility. If the market experiences a downturn, you will incur a loss that might exceed your initial investment.
  • Margin Call: If the value of your securities pledged as collateral falls, you will receive a margin call. To maintain the margin requirement in a margin account, it is essential to deposit funds.

Final Word

By now, you must have a clear understanding of margin loans and how it works. Margin loan is an invaluable tool for investors looking to amplify their returns from the market. It allows investors to borrow funds for purchasing securities. However, it is a high-risk investment strategy. If the market moves against your position, your losses will be magnified. Moreover, you could face a margin call.

Thus, before opening a margin account, conduct thorough research regarding current market conditions to maximise investment effectively. If you are a novice investor, consult with a financial advisor to assist you in forming a borrowing strategy with all probable risks involved.

Other Words

  • Mortgage Loan
  • Maturity Date of Loan

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