Margin account documents

A margin account lets you buy with the firm's money

You want to buy 10,000 dollars of stock, but you only have 5,000 dollars. You wonder if your brokerage firm can cover the rest. It can, in a margin account. A margin account is an account where you buy securities partly with money borrowed from the firm. In a cash account, you pay the full price yourself.

It works like a car loan. You put some money down, and the lender covers the rest. Every loan like this has collateral. Collateral is something you pledge that the lender can take if you don't pay. With a car loan, it's the car.

In a margin account, the collateral is the securities you buy. They stay in the account, held by the firm. So the firm is covered if you don't pay it back. The amount you owe the firm is called the debit balance. The firm charges you interest on it, like any loan.

A common mistake is treating margin like free money. It's a loan, you pay interest on it, and your securities back it. A margin account lets you buy partly with money borrowed from the firm, with your securities as collateral.

Two papers every margin customer must sign

A margin account lets you buy partly with money borrowed from the firm. A loan needs paperwork, so the customer must sign two documents first. The first is the credit agreement. The credit agreement sets the terms of the loan, including how interest on the debit balance is charged.

Remember, the debit balance is what you owe the firm. It's like the loan papers at a car dealer, which say your rate and how it's figured. The second is the hypothecation agreement. To hypothecate means to pledge something as collateral for a loan. You're pledging your securities to back your margin loan.

This agreement also lets the firm repledge your securities to its bank. That's how the firm gets the money it lends you. Repledging is called rehypothecation. There's a limit. The firm may repledge securities worth up to 140 percent of your debit balance. Anything above that must be kept apart for you, which is called segregated.

A common mistake is swapping their jobs. The credit agreement covers the loan's terms and interest. Hypothecation covers pledging the securities. Every margin account needs two signed documents: the credit agreement and the hypothecation agreement.

The loan consent is optional; the risk notice comes yearly

A margin account lets you buy with money borrowed from the firm, backed by your securities. Two documents are required. A third one is optional, and the customer can say no. It's the loan consent. The loan consent lets the firm lend your securities to other customers or other firms.

They usually go to short sellers. A short seller borrows shares to sell now, hoping to buy them back cheaper later. Think about your car. Pledging it for a loan is one thing. Lending it to a neighbor is another, and that needs your separate OK.

If a customer refuses the loan consent, the margin account still opens. The firm just can't lend her securities to anyone. One more paper is handed out, not signed. The margin disclosure statement explains the risks of margin. Retail customers get it at or before opening, and again at least once a year.

A common mistake is calling the loan consent required. Only the credit agreement and the hypothecation agreement are. The loan consent lets the firm lend your securities to others, and it's optional.

Worked example: no loan consent, $15,000 debit

1. Lena opens a margin account. She signs the credit agreement and the hypothecation agreement, but she refuses the loan consent. Later she owes the firm 15,000 dollars.
2. What she owes the firm is her debit balance, so her debit balance is 15,000 dollars.
3. Start with whether the account can open. Both required documents are signed, and the loan consent is optional. So it opens.
4. Next, how much of her stock can the firm repledge to its bank? The hypothecation agreement allows up to 140 percent of the debit balance.
5. Multiply 15,000 dollars by 1.4. That gives 21,000 dollars.
6. Any of her securities worth more than that stay segregated, which means kept apart for her.
7. Last, the firm can't lend her shares to short sellers. That needs the loan consent, and she said no.

Common mistakes

the loan consent is optional

You treated the loan consent as required. Only two documents must be signed: the credit agreement and the hypothecation agreement. The loan consent lets the firm lend out the securities. It's optional, and the account opens without it. Lending the securities is the optional part.