Why would the brokerage firm want to lend me money to buy on margin?

If you're familiar with the concept of buying stocks on margin, then you know the broker will lend an investor up to 50% of the purchase price of the stock. Buying on margin allows an investor to pay half of a stock's price with his own equity and then borrow the rest. For example, let's say an investor has $20,000 in a margin account. That gives him $40,000 of buying power, since the broker will give you up to double what your cash equity is.

Buying on margin is risky, but it can also yield great returns to the investor. For example, it gives you leverage by allowing you to purchase more stocks by using your assets you already have as collateral for the loan, it can up to double your buying power and result in greater returns, and it also lets you to react quickly to new investment opportunities because you have the added money in your account.

But don't think the investor is the only one who stands to make money. If you're wondering why the brokerage firm is willing to loan money, it's because they're making a good deal of profit from the margin as well, regardless of whether the stock does well or not.

So how does the brokerage firm benefit from lending money on margin? Here are just a few ways:

• Commission. As with all accounts, margin or not, the broker gets a commission. When an investor with a margin account invests wisely and yields a larger return, then obviously the broker's commission will be larger as well.
• Interest. Also called the broker's call or call loan rate, this is the interest rate an investor pays to the broker for borrowing money from him. This amount is usually around 10 or 11% and can change at any time. The interest is deducted on a monthly basis from your account. The call rate changes on a daily basis and is published daily in the Wall Street Journal.
• Access to your account. Should your cash equity fall below a certain amount, your broker will issue a margin call. A margin call means the investor much put more money into the account to reach a certain percentage, and he usually has three days to do this. If he can't do this, however, he'll have to sell the stock, pay the broker the amount owed, which might even be more once commissions are figured in. If the money is not repaid within a certain time frame, the broker doesn't lose. There are no collection letters or penalties; the broker simply sells your stock (he can do this without your permission) in order for the investor to meet the correct amount.
• Complete control. The broker can change the broker's call rate at any time.

As you can see, buying on margin benefits the broker no matter what, so in many cases they are willing to loan the investor money; no matter what happens with the stock, they will get the money back and then some. While the investor may be facing huge financial losses from buying on margin (a very real possibility), the broker will still be able to collect commissions and interest. In addition, if the investor ends up making a good deal of money, the broker will still make a great deal of money.

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