Stock investing has become more popular as online brokerage firms have made these assets more accessible. According to Gallup, approximately 62% of Americans own stocks, and a growing number of stockholders have become more brazen over the years. Not only are more people buying stocks, but more people are using margin and options to leverage their portfolios.
Research from Hearts and Wallets concluded that 6 million to 7 million households use margin, and 16% of households made at least one options trade within the past year.
[Sign up for stock news with our Invested newsletter.]
The research also indicates that there are many people sitting on the fence. They’re actively considering margin and options but haven’t taken the leap quite yet. These trends likely mean there will be more people who owe money in their investing apps.
This guide covers important details for anyone who has a negative cash balance in their brokerage account. You’ll learn when you have to pay it and what can happen if you have a negative debt and are wiped out by a bad options trade.
— How do people end up owing money on their investment apps?
— When do you have to pay back margin?
— Some people never pay margin.
— Is margin investing worth it?
— You don’t have to invest on margin.
How Do People End Up Owing Money on Their Investment Apps?
Trading with margin is the only way to end up owing money to your brokerage. If you do not use margin, you do not have to worry about paying off debt related to your portfolio.
Ben Waterman, co-founder and CEO at Strabo, explains how people accrue debt in their brokerage accounts: “People end up owing money to investing apps by investing with leverage. When entering into trades with an investment brokerage, you can borrow money to amplify your trades.”
It’s not just day traders who use margin to amplify their returns, however. Long-term investors also borrow money to expand their positions. They receive extra money from a brokerage firm to capitalize on near-term opportunities. Some investors prefer having more shares with leverage than being limited to the funds in their bank accounts.
When Do You Have to Pay Back Margin?
Although margin can go very well for you when the stock market marches higher, it can work against you in a big way if your positions steadily lose value.
“If they go badly, your principal disappears, and you could find yourself underwater,” says Waterman. “By trading with leverage, you are often only one bad trade away from being wiped out, which is a very precarious position to be in.”
That one bad trade can lead to you owing money that must be paid, and brokerage accounts don’t show any mercy when it comes to liquidating positions. David Materazzi, CEO at Galileo FX, reveals how quickly margin debt can become a big issue if you aren’t careful: “The moment the value drops below maintenance, the broker sells positions to cover the loan. If that isn’t enough, the client owes the rest in cash. Most don’t realize borrowed money can turn into personal debt within hours.”
Materazzi also elaborates on what happens to options traders who borrow money for speculative options trades and wipe out their portfolios. It’s not pretty.
“The broker liquidates immediately. If the loss exceeds the account value, the debt is transferred to collections. It becomes a legal and financial problem, not just an investing mistake. Credit is damaged. Lawsuits are possible. The loss becomes real and permanent.”
[How to Become a Millionaire by Investing]
Some People Never Pay Margin
While most people look at debt as something that must be paid, some investors never pay off their margin. It’s not exactly free money, since interest will accrue over time. However, if your long-term returns exceed the interest rate, margin will actively grow your money.
Brokerage firms won’t care about your positions or strategies if you fall below the margin requirement where you’ll face a margin call and possibly end up with forced liquidations. However, if you do it correctly, you can end up never having to pay margin.
“In general, you don’t pay margin if your portfolio goes up, but this can depend. If you have a portfolio made up of multiple open trades, you could owe margin on some trades but not others. The net position of your portfolio could be positive, but you could still go underwater on individual trades,” Waterman says.
Although you don’t have to pay margin as long as you don’t trigger a margin call, Materazzi warns investors about ignoring the debt because it can come back to bite them during an inconvenient moment: “The loan doesn’t disappear. It sits there, waiting. When prices fall, even a little, the broker takes control. They sell what they must. If that’s not enough, you pay. Margin doesn’t forgive.”
Is Margin Investing Worth It?
Margin investing can multiply your returns and let you capitalize on near-term opportunities even if you don’t have enough cash in your bank account. Your funds can grow rapidly if you make the right investments and timing is on your side.
However, a margin trade gone wrong can lead to quick losses, especially if you make speculative options trades. You also have to earn a higher return than the margin rate to justify using margin. For instance, if your portfolio goes up by 5% this year, but you have an 8% APR on your margin loan, you’re down by 3 percentage points on the borrowed money.
Investing in margin automatically qualifies as being willing to take high risks. Combining margin with another high-risk strategy, like options that expire in a few hours, can be a recipe for disaster. Investors who want to trade with margin and get exposure to options may benefit more from long-dated, deep-in-the-money options for positions that they want to hold in the long run. This approach is less risky than buying options that are substantially out of the money.
If it’s not obvious by now, trading with margin isn’t for the faint of heart. You should have a few years of experience in buying stocks. It’s not recommended for beginners, especially people who are prone to letting their emotions guide some of their investments.
As Mike Tyson said, “Everyone has a plan ’til they get punched in the mouth.” A bit of unfavorable volatility can cause many traders to panic, especially if they use margin.
You Don’t Have to Invest on Margin
While margin can amplify your gains and losses, some people use margin as a traditional loan. You can withdraw your margin balance and transfer the funds to your bank account for various purchases. Margin loans can be useful for home improvements and consolidating credit card debt. These loans have lower rates than most unsecured debt, especially credit cards.
Furthermore, as your portfolio grows, you’ll be entitled to lower interest rates. It’s also worth noting that there is no complete application process or origination fees associated with a margin loan. You don’t have to wait a few weeks for a lender to approve your home loan when you can withdraw funds from your margin accounts in seconds. Margin accounts also do not require any credit checks.
The only downside with this strategy is that paying off a margin loan won’t impact your payment history, a key component of your credit score. However, you can receive quick funds with this strategy at rates lower than most conventional loans.
Some brokerage firms have margin rates that are below 5% APR, depending on your balance. It’s worth shopping around instead of committing to your current brokerage firm. Companies like Vanguard, Fidelity and Schwab usually have higher APRs on margin than newer brokerage firms.
A margin account also lets you use the “buy, borrow, die” model that high-net-worth individuals use to avoid taxes. Instead of selling assets with substantial capital gains, you can borrow against them and pay low interest rates. When you pass away, your heirs will inherit your stocks at the stepped-up basis, so they won’t have to worry about capital gains.
Margin gives investors more options and flexibility with the strategies that they can pursue. Understanding the high-risk nature of margin investing can help you plan accordingly.
More from U.S. News
Best Investment Apps For Beginners In 2025
6 Apps for Socially Responsible Investing
Can AI Pick Stocks? 5 AI Investing Apps to Try
I Owe Money in My Investing App. Do I Have to Pay It? originally appeared on usnews.com
