What is a Margin Debt?

A margin account is an account that a stock brokerage firm uses to loan its customer money to purchase securities. The market value of the securities purchased serves as collateral for the loan. Margin debt refers to the difference between the market value of the collateral deposited and the loan balance, plus accrued interest. Not all securities can be purchased on margin. Securities that can be purchased on credit in a margin account are called marginable. Most low-priced, highly volatile, or speculative stocks are not marginable.

In the U.S., the maximum percentage amount of securities that can be purchased on credit, or margin, is established under regulations issued by the Federal Reserve Board. For example if the margin percentage in effect is 50%, a customer could purchase $100 US Dollars (USD) worth of marginable securities with an initial cash deposit of $50 USD. The brokerage firm would then lend the customer the other $50 USD to effect the transaction. Individual brokerage firms may establish their own credit requirements, which may be lower than the maximum levels established by the Federal Reserve.

The amount of margin debt in a customer’s account will fluctuate based on the market value of the securities purchased in the account. Since the value of the securities in a margin account may change based on overall market conditions, after a customer has initially purchased securities on margin, he must thereafter maintain a specified percentage, or minimum margin, in the account at all times. For example, if the minimum maintenance margin requirement is 25%, the equity in a customer’s account — market value of securities minus outstanding loan balance — must be at least 25% of the total account value. Brokerage firms may establish minimum margin requirements that exceed those established by the Federal Reserve.

If the market value of the securities in a customer’s margin account falls below the required minimum margin maintenance level, the brokerage firm will send the customer a margin call. The customer must increase the cash or securities in his account to bring the value of the account up to the minimum maintenance margin level. If the customer does not comply with the margin call, the brokerage firm will sell an amount of securities in the account to bring the equity in the account up to the minimum margin maintenance level.

The total amount of margin debt in effect at any time is often used as an indicator of prevailing investor sentiment. In general, an increase in margin debt levels coincides with broad-based stock market rallies. In many cases, a precipitous drop in the stock market may trigger margin calls, resulting in the sale of securities in customers’ accounts, which may exacerbate the market’s decline.