What is Free Credit Balance?
The cash retained in a customer’s margin account at a broker-dealer that may be withdrawn on demand at any time is referred to as the free credit balance. The entire uninvested residual money in a margin account after margin requirements, short sale profits, earned dividends, and buy transactions pending settlement are deducted is the free cash balance. Brokers will sometimes pay interest on the free credit amount.
- The free credit balance is the amount of money available for withdrawal after accounting for all transactions and margin requirements.
- Some brokers pay interest on free credit balances, but not all.
- The SEC and FINRA control free credit balances in the United States.
Understanding the Free Credit Balance
The credit balance in a cash account is the amount of money that remains after all purchases and is not subject to withdrawal limits. However, the credit balance of a margin account comprises not only the cash left in the account, but also revenues from short sells, money needed to fulfill margin needs, and surplus margin and purchasing power. Because the credit balance of a margin account comprises both unrestricted and restricted amounts, the free credit balance is calculated to determine the total amount that the account user may take.
While it is not required by law, some brokers pay interest on cash held in free credit balance accounts by consumers. Some brokers allow account users to move monies from their free credit balance accounts into short-term and highly liquid accounts such as FDIC-insured bank accounts or money market funds on a regular basis. Brokers that provide this option must have a policy in place and adhere to it in order to acquire clients’ authorisation, whether oral or written, to execute transfers or invest monies kept in these accounts.
Regulations Covering Free Credit Balances
Credit balance accounts are extensively regulated since the monies stored in them are client funds maintained by brokers. Regulations are intended to protect broker-dealers from misusing client cash, as well as the loss of funds if a broker becomes insolvent or has liquidity problems.
The Securities and Exchange Commission (SEC) requires brokers to calculate the quantities of monies owed to or receivable from a customer’s free credit balance account on a weekly basis. The Financial Business Regulatory Authority (FINRA), the self-regulatory body for the brokerage industry, mandates brokers to provide written statements to consumers once a quarter, unless customers opt out of receiving such statements. On a monthly basis, FINRA also requires brokers to give data on the total sums they hold as of month end in free credit balances in both margin and cash accounts.
Examples of Free Credit Balances in Trading Accounts
Assume a $10,000 investment into a margin trading account. If no transactions are made after the money are deposited, the free credit balance is $10,000. This is the amount of money that may be traded or withdrawn.
Assume the trader pays $50 for 100 shares of stock. This is $5,000. Their free credit balance has now increased to $5,000. (excluding commissions).
Cash dividends on positions will be added to the free credit balance. Assume the investor earns $50 in dividends on their investment. Their free credit balance has now increased to $5,050.
The broker may also pay the investor interest on the free credit balance. If this is the case, interest will be paid on the free credit balance, increasing its total.
If the stock was bought on 50% margin, the trader must keep at least $2,500 of the $5,000 position to finance the deal. The free credit amount in this scenario is $7,500 ($10,000 – $2,500), without commissions.
The trader must pay interest on margin holdings. The free credit balance will be reduced over time as interest is taken from it. At the same time, if the broker provides it, interest may be paid on the free credit balance.
Dividends received, similar to the no margin account example, will be added to the account balance and will boost the free credit balance.
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