What is Buying on Margin
Buying on margin refers to buying of securities with borrowed money. This money can be borrowed from the bank or the broker. It is a risky situation. The securities themselves act as the collateral in this case. There are strict SEC regulations that have to be followed in order to have margin buying. In simple terms it means to take a loan to buy stocks. This will enable the investor to buy more than he normally can.
To be able to buy on margin the investor needs to open an account called the margin account. This margin account differs from the normal cash account. The margin account is opened by the broker. The broker has to make sure he takes the signature of the investor before opening the account. There is a certain balance that needs to be maintained in order to keep the margin account working; it is called the minimum margin.
The loan that is given to the investor is not of the total amount of the security. At least fifty percent of the amount has to be invested by the investor. The remaining fifty percent can be taken as the loan. The amount that the investor invests from his side is called the initial margin. It is not necessary to borrow fifty percent only. The borrowed amount can be lower also. But there can be some brokers who may require the initial margin to be more than fifty percent.
There is no fixed time period to repay the loan. It can be kept for any period of time as long as the two essential conditions are fulfilled. The first condition is that any gain that is made from the security, be it by selling the security or otherwise, the gain shall go to the brokers account in order to repay the loan. This will continue as long the loan is repaid.
The second condition is that a minimum amount of maintenance margin has to be kept. This is the minimum balance the margin account should have. If it goes lower than this balance the broker can force the investor to deposit money. This situation is called a margin call. When a margin call is made the investor needs to deposit the money equal to the shortage from his maintenance margin.
Buying on margin is usually used for short term investments only. This is because this loan is not interest free. Interest needs to be paid on this loan amount. The interest will keep on increasing if the deposits are not made regularly or the securities are making any profits. In such a case the interest will keep on accumulating.