What is Margin Lending?

Malcolm Tatum

Margin lending is a type of loan arrangement in which a lender approves a loan to a client for the express purpose of investing those funds into one or more investment opportunities. Lending institutions that offer this type of loan typically consider the type and value of the assets currently owned by the applicant as the means of determining the amount that the institution is willing to lend. For the duration of the loan agreement, at least a portion of those assets are pledged as collateral, a move that helps to keep the level of risk assumed by the lender to a minimum.

Man climbing a rope
Man climbing a rope

The process of margin lending can have benefits for just about everyone involved in the process. The recipient of the loan is able to move forward with investments that he or she could not fund otherwise, without having to actually liquidate any assets to secure the needed capital for the venture. At the same time, the broker who is involved in the deal typically collects at least a portion of the interest that the debtor pays on the loan. Since it is common to secure the loan with assets found in the trader’s investment account, the lender is highly likely to be repaid according to terms. Even if the debtor does default on the loan, recovery is relatively quick and easy, requiring little more than exercising the right to claim the pledged assets and having them transferred to the lender’s trading account.

With margin lending, investors have the opportunity to move quickly on what shows promise of being a lucrative deal. It is not unusual for investors to use this approach to buy into a good investment that is held for the short-term as the securities experience a rapid increase in unit price, selling the shares just as that upward price movement begins to level off. As a result, the investor is able to retire the outstanding balance of the margin lending, including any interest due on the loan, and use the profits from the venture for whatever purpose the investor desires.

Just like any other type of borrowing situation, margin lending does require that the applicant meet the basic criteria outlined by the lender. The current value of assets in the trading account help to determine the maximum amount that the investor can borrow at the present time. In addition, the past activity of the investor will also be taken into consideration. This means that if the investor has borrowed on margin before and repaid the balance according to terms, he or she is more likely to be approved for another loan. Should the investor have a history of slow pays on the loan balances, or even a default at some point in the past, the lender may not approve the application or may require some sort of additional collateral in order to further protect his or her interests.

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