What is a Debit Balance in Margin Accounts?
The debit balance in a margin account represents the amount of money a brokerage customer owes to their broker for funds borrowed to purchase securities on margin.
Key Takeaways
- The debit balance measures the customer’s borrowed funds used to purchase securities.
- There are two main account types: cash accounts and margin accounts.
- Cash accounts limit transactions to the available balance, while margin accounts allow borrowing for additional investments.
- Margin borrowing—leveraging—can amplify both gains and losses.
- Financial regulations enforce limits on borrowing amounts (initial margin) and required account equity (maintenance margin).
- Insufficient maintenance margin triggers a margin call.
How Does a Debit Balance Work?
Investors borrow broker funds to supplement their own when buying on margin, thereby increasing potential profits through leverage.
Investors use two primary types of brokerage accounts:
- Cash Account: Allows purchases only up to the cash balance on hand. For instance, a cash account with $2,000 limits purchases to $2,000 worth of securities, unless additional funds are deposited.
- Margin Account: Enables borrowing from the broker to buy more shares or to facilitate short sales. Borrowing is backed by pledging account securities or cash as collateral.
For example, an investor with $2,000 cash might need $3,000 worth of shares. The broker could lend $1,000, creating a debit balance of $1,000 in their account.
What is an Adjusted Debit Balance?
An adjusted debit balance is an account’s total outstanding debt minus short sale profits and special memorandum account (SMA) balances.
This balance reflects what the investor would owe upon a margin call, a demand to repay borrowed funds if the account’s equity falls too low.
Federal rules (e.g., Regulation T) cap margin borrowing at 50% of a security’s purchase price, forming the initial margin. Firms also set maintenance margin requirements ensuring account equity remains above a minimum threshold—typically at least 25% of a margin account’s market value.
Should You Be Concerned about Interest on the Debit Balance?
Yes, brokers charge interest on lent funds, impacting overall profits. Investors should inquire about interest rates before opting for margin buying, as they reduce potential gains.
What is a Special Memorandum Account?
A Special Memorandum Account (SMA) accompanies a margin account, holding excess margin beyond maintenance needs. The SMA secures gains, offers a credit line for future margin purchases, and buffers against declines, helping avoid margin calls.
What Happens During a Margin Call?
A margin call occurs if an account’s equity drops below the broker’s maintenance requirement. This necessitates additional deposits to restore the balance. If not addressed promptly (typically 2-5 days), the broker may sell securities to cover the shortfall—without prior notification.
What Are Marginable Securities?
Marginable securities include stocks, bonds, and other assets purchasable on margin or usable as collateral within a margin account. Each firm decides the marginability status of various securities; non-marginable items must be fully paid with the investor’s cash.
How to Avoid a Margin Call
To sidestep margin calls, maintain a robust cash buffer and monitor account metrics relative to maintenance margins. Alternatively, opt for a cash account avoiding margin transactions altogether.
The Bottom Line
A debit balance reflects borrowed funds in margin transactions. Managing this balance is crucial to avoid margin calls by consistently tracking account equity and readiness to infuse additional cash if necessary.
Related Terms: Margin Account, Cash Account, Leverage, Collateral, Short Sale, Special Memorandum Account.
References
- NASDAQ. “Adjusted Debit Balance”.
- U.S. Securities and Exchange Commission. “Investor Bulletin: Understanding Margin Accounts”.
- U.S. Securities and Exchange Commission. “Investor Bulletin: Interested in Margin? Understand Interest”.
- FINRA. “Adoption of Revised and Simplified Regulation T of the Federal Reserve Board”.
- FINRA. “Understanding Margin Accounts, Why Brokers Do What They Do”.
