For example, an investor might open a margin account with their broker to borrow funds. The investor might have $10,000 in cash but be so confident in an investment opportunity that they want to borrow another $10,000 from their broker. This transaction enables them to then buy $20,000 worth of stock. That $10,000 margin loan equals the debit balance. Eventually, the investor will have to pay back that debit balance. Ideally, the $20,000 worth of stock would increase in value, allowing the investor to pay off the debit balance with the proceeds. But, in the event the investment decreases, the investor would still owe the debit balance, so they could generally pay it off from the $10,000 in cash they initially put in. In that case, however, they would be losing money. A debit balance could also be created if an investor withdraws more cash than they have within a margin account. Suppose the value of the stocks within an investor’s margin account goes up by $2,000 but they don’t have any cash available in that account. The investor might then decide to withdraw $2,000 to use as cash in their personal life, rather than selling shares. So, that $2,000 withdrawal is a loan that’s part of their debit balance.
How Does a Margin Debit Balance Work?
A margin debit balance works by adding up the money borrowed from a lender. Keep in mind that brokers may have their own lending rules or at least follow minimum requirements from organizations such as FINRA and the Federal Reserve, which affect potential debit balances. For example, The Federal Reserve Board’s Regulation T limits the amount of margin that can be used for stock purchases to 50% of the purchase price. So, if you only deposited $5,000 in cash into your margin account, you would be limited to borrowing $5,000 on margin to then purchase a total of $10,000 worth of stock. From there, you need to maintain at least 25% equity based on the value of your margin account, based on FINRA rules. This amount is known as the “maintenance requirement.” Your broker may require higher amounts. To calculate this equity, simply take the value of your securities minus your debit balance. Let’s look again at the example where you initially put in $10,000 in cash and borrowed $10,000 as your debit balance to buy $20,000 in stock. If the stock declines to a value of $15,000, and you subtract your $10,000 debit balance (i.e., what you owe), you’re left with $5,000 in equity. While that’s less than the $10,000 in cash you started with, your account still meets FINRA’s maintenance requirement, as the $5,000 in equity is more than 25% of the $15,000 in current securities value. However, suppose the value of the securities dropped to $10,000. When subtracting your $10,000 debit balance, you would be left with $0, meaning you have no equity. This isn’t allowed, so you would face a margin call from your broker to get back to at least that 25% level. If you don’t have the cash to do so, your broker can sell securities on your behalf. Doing so protects the broker. Even if you lose your initial cash investment, they want to be able to recover the debit balance.
What Margin Debit Balances Mean for Individual Investors
People who want to borrow money from a broker or similar lender, such as to open up a margin account and make more aggressive investments, should understand their responsibilities when it comes to paying off a debit balance. Lenders may have their own rules in place to limit their own risk, which in turn can increase investors’ risk. You don’t want to be caught by surprise by a margin call, for example, and have to sell off assets at inopportune times. If you do use margin, you generally want to be in a position where you’re comfortable paying off your debit balance, whenever that time may come.
