A house maintenance requirement is the level of minimum margin account equity that is required by a brokerage firm. These levels are established based on the standards set out in Regulation T of the Federal Reserve.
Even though Regulation T specifies the minimum maintenance requirements permitted by law, brokerage firms have the freedom to set their own “house” maintenance requirements, provided their standards are more rigorous than the regulatory minimums.
Key Takeaways
- House maintenance requirements are the standards for minimum margin account equity levels chosen by brokerage firms.
- They must be greater than or equal to the 25% level stipulated in Regulation T, often ranging from 30% to 50%.
- Some brokerage firms may grant lower house maintenance requirements for larger or more sophisticated clients, but these figures will always be at or above the 25% minimum.
- Requirement levels may vary depending on the type of investment, with more volatile, less liquid investments likely to necessitate higher equity for protection.
How House Maintenance Requirements Work
The purpose of maintenance requirements is to ensure that investors using margin accounts for leveraged investments don’t end up unable to repay their margin loans. These requirements aim to reduce credit risk for brokerage firms and, by extension, reduce the systemic risk that might come from widespread defaults by margin traders.
House maintenance requirements typically range from 30% to 50%. While stocks are the security most commonly purchased in a margin account, many other securities such as mutual funds, Treasuries, corporate bonds, and options may be purchased “on margin” subject to differing purchase and maintenance requirements.
According to Regulation T, margin traders must maintain equity levels of at least 25% of their investment value. Failure to maintain this level can result in a margin call from their broker. In such a case, the trader would be required to promptly deposit additional collateral into their account. If this isn’t done, the broker is authorized to liquidate the investor’s positions to repay the margin loan.
Bull vs. Bear Markets: Why Maintenance Requirements Are Necessary
During bull markets, margin traders might see maintenance requirements as overly restrictive. When asset prices are on the rise, leveraging more can be tempting to maximize return on equity (ROE). However, the dangers become evident when the market reverses.
In bear markets or periods of sudden financial shock, such as the 2007-2008 financial crisis, margin traders face significant risks. Declining portfolio values and the looming need to repay large margin loans on short notice (due to margin calls) can create considerable financial stress. In some cases, traders may lose all previous gains and even have to liquidate other personal assets to settle their margin loans. Thus, the importance of maintenance requirements becomes clear.
What Impacts House Maintenance Requirements
Often higher than the maintenance margin set by Regulation T, which mandates equity levels of at least 25%, house maintenance requirements are pivotal in margin trading.
Borrower Profile
Brokerage firms usually implement higher and more stringent house maintenance requirements than those stipulated by Regulation T. These standards often vary based on the account holders’ sizes, creditworthiness, or perceived sophistication. For instance, smaller and less experienced margin traders might be required to maintain a 40% house requirement, unlike larger, more experienced clients who may have a 30% threshold.
Type of Trade
Different investments impact maintenance requirements. Smaller, more volatile stocks generally necessitate higher margin requirements compared to more established, large-cap investments like those in the S&P 500.
Frequently Asked Questions
What is the minimum maintenance requirement?
The legally mandated minimum maintenance requirement is 25%, as set by Regulation T. However, brokers often demand higher percentages.
What does a 30% maintenance requirement mean?
If an investor has a 30% maintenance requirement and they borrow on margin, they need to maintain at least 30% of the total market value of the securities in their margin account at all times. For example, if the borrowed securities are valued at $20,000, the maintenance requirement would be $6,000.
What is a special maintenance requirement?
Not all securities follow uniform maintenance requirements. Riskier investments typically have higher requirements, which is usually true for more volatile or less liquid investments.
The Bottom Line
A house maintenance requirement is the minimum equity an investor must hold in their margin account after making a purchase. Once a security is purchased on margin, the requirement comes into play. Regulation T mandates maintaining at least 25% of the securities’ total market value in the account. Brokers, however, tend to have more stringent rules. It’s crucial to pay attention to these requirements, as falling below them and failing to act promptly may result in brokers liquidating your investment positions to reimburse the funds.
Related Terms: margin account, brokerage company, collateral, systemic risk, bear market, bull market, leveraged investments, margin call.
References
- Code of Federal Regulations. “Part 220—Credit by Brokers and Dealers (Regulation T)”.
- Financial Industry Regulatory Authority. “Know What Triggers a Margin Call”.
- Financial Industry Regulatory Authority. “Brokerage Accounts: Margin Accounts”.
- TD Ameritrade. “Margin Handbook”, Page 6.
- Charles Schwab. “The Charles Schwab & Co. Guide to Margin”. Pages 12-20.
