What You Need to Know About Margin Loans
When investing, an individual can choose to operate a cash account or a margin account. With a cash account, the account holder buys stocks with his or her own money and is limited by the amount of money in his or her account. When an individuals buys on margin, he or she puts up some of the money to make a purchase and borrows the rest.
Example of a Margin Loan
Let’s say that a broker offers a 50 percent margin. This means that to buy a $100 stock, the buyer pays $50 of his or her own money and borrows the other $50. At some point, ideally after you sell a stock that has increased in value, you repay the loan plus interest.
Pros of a Margin Loan
The best reason to buy on margin is that you have more buying power. Typically, a broker will give you a margin of 4 to 1, which means you can trade $4 for each $1 that you have in your account. If a stock grows in value, your return is higher because you put up less of your own capital. For instance, if you paid $1,000 for $1,000 worth of stock in a cash account and you finished the day with $1,100, that would be a 10 percent gain. However, if you bought $4,000 worth of stock with that same $1,000 and the stock went up 10 percent, you would make a profit of $400. That would be a 40 percent gain on the money that you actually put up yourself to make that purchase.
Cons of a Margin Loan
A big downfall with margin trading is that you could lose more than you risked if the stock declines in value. Additionally, just as your gains are larger when stocks appreciate, the losses are amplified as well when you trade with a margin account. You also have to pay interest on the borrowed funds as you would with any other loan product. Finally, if the equity in your account drops below the minimum required amount, you could be subject to a margin call. This means you have to deposit additional money or risk having portions of your portfolio liquidated.
Who Offers Margin Loans?
Most major brokers offer margin loans assuming you have enough capital and want to trade with margin. Examples of those who offer such loans include TD Ameritrade, E*Trade and Fidelity. While Charles Schwab doesn’t offer margin trading, Options Xpress, which is operated by the company, does offer them.
Trading with a margin account carries risks that may not be suitable for all investors. Therefore, you should only trade with cash unless you can afford a potential margin call or are willing to accept the potential pitfalls that come with such a trading arrangement.
While margin loans may be good for some you should really check out the interest rates on these products as they have higher rates. One person called them the payday loans for stocks. So be careful out there investing with a loan with either a credit card or one of these options.