What Is a Margin Call and How Do You Handle One?

A margin call is a formal demand from a brokerage firm for an investor to deposit additional money or securities into their margin account. This demand arises when the equity in the account falls below a specified minimum maintenance level. It indicates the value of the collateral for the broker’s loan has diminished, posing an increased risk, and aims to restore the account’s equity to the required threshold, safeguarding the brokerage firm’s position.

Understanding a Margin Account

A margin account is a brokerage account that allows investors to borrow money from their broker to buy securities. This differs from a cash account, where all transactions must be made with the investor’s available funds, limiting purchases to the amount of cash on hand. Investors use margin accounts to employ leverage, aiming to amplify potential returns by controlling a larger position of securities than their own capital would permit. While leverage can magnify gains, it also significantly increases the risk of magnified losses.

Initial margin refers to the percentage of the purchase price an investor must pay with their own money when first buying securities on margin. Federal Reserve Board’s Regulation T sets this initial requirement at 50% for most stock purchases. For instance, to buy $10,000 worth of stock, an investor needs to deposit $5,000 of their own funds, with the remaining $5,000 borrowed from the broker.

Maintenance margin is the minimum equity percentage an investor must maintain in their margin account. The Financial Industry Regulatory Authority (FINRA) mandates a minimum maintenance margin of 25% of the total market value of the securities held long. Many brokerage firms establish their own “house” maintenance requirements, often higher (30% to 40%), for additional risk protection. These requirements adjust based on market conditions or security volatility.

Equity in a margin account is calculated as the current market value of the securities held minus the amount borrowed from the broker. For example, if an investor holds $20,000 worth of securities and has borrowed $10,000, their equity is $10,000. The equity percentage is then this equity amount divided by the current market value of the securities, multiplied by 100. A decline in securities’ value directly reduces equity, potentially triggering a margin call.

How a Margin Call Occurs

A margin call is issued when the equity in an investor’s margin account falls below the required maintenance margin percentage. This occurs when the market value of securities purchased on margin declines. As securities value drops, account equity decreases while the borrowed amount remains constant, causing the equity percentage to fall.

Consider an example: an investor buys $20,000 worth of stock, contributing $10,000 of their own capital and borrowing $10,000 from the broker. The initial margin is 50%. If the brokerage firm has a maintenance margin requirement of 30%, the investor’s equity must remain at or above 30% of the securities’ current market value. Should the stock’s value drop to $14,000, the investor’s equity would become $4,000 ($14,000 market value – $10,000 borrowed). The equity percentage would then be approximately 28.57% ($4,000 / $14,000), which is below the 30% maintenance margin. At this point, a margin call would be triggered.

The margin call amount is the additional funds or securities needed to restore account equity to the maintenance margin. In the example above, to restore the equity to 30% of the $14,000 market value, the required equity would be $4,200 ($14,000 0.30). Since the current equity is $4,000, the margin call would be for $200 ($4,200 – $4,000). This amount must be deposited to cover the shortfall.

Margin calls can also occur if the brokerage firm raises its “house” margin requirements for specific securities, especially during high volatility or financial distress. Even without a decrease in account value, an increased maintenance margin percentage can cause existing equity to fall below the new requirement, triggering a call. Brokers are not required to notify investors in advance if their account equity drops below the minimum maintenance level, meaning investors must actively monitor their accounts.

Responding to a Margin Call

Upon receiving a margin call, an investor has a limited timeframe to address the deficiency, usually a few business days (two to five days). Brokerage firms often set specific deadlines. Several common ways exist to satisfy a margin call.

One direct method is to deposit additional cash into the margin account. This increases account equity and reduces the shortfall. The amount of cash deposited must be at least equal to the margin call amount.

Another option is depositing additional margin-eligible securities. When using securities, their value must exceed the margin call amount, as only a percentage (determined by broker requirements) counts. This increases collateral without immediate cash outlay.

Alternatively, an investor can sell existing securities in the margin account. Proceeds reduce the outstanding loan balance, increasing account equity. When selling, enough shares must be sold to bring equity above the maintenance threshold. This approach may involve selling positions at a loss, especially if the market has declined.

Consequences of Not Meeting a Margin Call

Failing to meet a margin call within the specified timeframe leads to severe financial repercussions. The brokerage firm can take immediate action to protect its loan, often without prior notice. This is part of the margin agreement signed when opening the account.

The primary consequence is forced liquidation of securities. The broker can sell any securities held, regardless of whether they caused the margin call. This means the investor loses control over which assets are sold, and sales may occur at unfavorable market prices, crystallizing significant losses. Brokers prioritize selling enough securities to cover the margin debt and restore the account to minimum maintenance.

Beyond the forced sale, the investor remains responsible for any remaining debit balance if liquidation proceeds are insufficient to cover the loan and associated costs. This could result in a negative account balance, meaning the investor owes the brokerage firm money even after all securities are sold. Brokers can pursue legal action to recover outstanding debt, impacting the investor’s credit rating and future investment opportunities. Additionally, the broker may impose administrative fees and interest charges until the debt is settled.