What is Margin?

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What is Margin?

When opening an account at Schwab, the first option on the account open form is whether you want a “Schwab One” account, their name for a standard brokerage account, or a “Schwab One with Margin” account. Margin is an optional feature that can be added to Schwab brokerage accounts.

If you have margin on your brokerage account, it means you have the option of borrowing money from your brokerage firm and using the value of your investments as collateral. This loan can be used to purchase more securities or be withdrawn from the account to meet other financial obligations.

Margin is only available on taxable investment accounts. You are not allowed to borrow money using retirement account or custodial account assets.

Investors who want to be able to borrow against the value of their accounts must sign a margin agreement either when the account is opened or later when they want to add the margin feature to their account.

Once you have a margin-approved brokerage account at Schwab, you can borrow up to 50% of the account value. For example, if you have securities worth $100,000 in your account, you can borrow $50,000. If you did this, your remaining account would contain $100,000 in securities, a -$50,000 margin loan, and would be said to be “on margin.”

Even though very few of our client accounts are ever on margin, we generally add the ability to have margin to most of our client’s taxable accounts. There are many infrequent occasions when having the margin feature is convenient.

Margin makes trade settlement dates less restrictive. If there is a cash deficit between the sale of stock and the purchase of mutual funds, margin can cover the deficit for the day or two it takes the sale to settle.

Margin also provides a quick method of getting cash from an account. Normally stock and exchange traded fund sales settle in three business days. An additional day is required to transfer the funds from your brokerage account to your checking account overnight.

This can result in a delay of up to four days between the moment you know you need money to the day the money is available in your checking account.

But if your brokerage account has the margin option, you can make the transfer and put in the sales the same day. Then, you have the funds after an overnight transfer and the sale of securities will clear up the margin in three days. Furthermore, because the cash is pending receipt at the same time you are officially on margin, often there are no margin charges at Schwab.

This ultra-short term loan concept can be extended into a short term loan in which you are on margin for a number of months.

Margin can be used when you are building a house and need a loan to get the house to the point where a conventional loan can be secured. This is normally done with what is called a builder’s construction loan. Builder’s loan are riskier and therefore at a higher interest rate. They are also often not for the full amount of the construction costs.

Margin loans, however are secured by securities worth at least twice their value. As such the interest rates are often competitive.

Currently, as of April, 2016, margin rates at Schwab are starting at a rate of 2.0% plus a base rate of 6.5%. The rate for a $200,000 loan is 0.375% plus the base rate. And while 6.875% isn’t a great rate for a home loan or a line of credit, it may serve well for a short-term building loan.

One way to think of margin is that it is like a payday loan for rich people.

Currently, payday loans for the masses are at a rate of 840%. At that rate, a payday loan for $2,000 for two months would cost $1,400 in interest. For that same amount of interest, an investor with the margin feature on their half million dollar account could borrow $244,000 for the same two months.

We don’t normally recommend being on margin, but we recommend having the option in case it is needed.

Photo used here under Flickr Creative Commons.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.

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