Explained: What is Margin Trading Facility (MTF), the 'buy now, pay later' option for stock purchases?

What do you do when you come across an attractive deal online but can't afford it due to a lack of funds?

You might delay your purchase, use a credit card to finance it or take advantage of the buy now, pay later (BNPL) options many online retailers offer.

Both credit cards and BNPL options allow you to make purchases immediately and pay for them later, often with interest and additional charges. This convenience isn't limited to online shopping; a similar facility also exists for stock market investors.

Known as the Margin Trading Facility (MTF), it allows investors to buy stocks they can't afford to pay the full amount upfront.

MTF enables investors to pay a small amount for their favourite stocks while the broker funds the balance. In this arrangement, the buyer or the investor repays the balance to the broker over time, along with interest. However, MTF is a high-risk option that investors shouldn’t use until they understand it completely.

Amid the buzz around MTF on social media these days, this article will help you understand how this facility works.

What is Margin Trading Facility?

Margin trading facility is a financial tool that enables investors to buy stocks by paying only a portion of the total value while the broker provides the rest. With the help of MTF, investors can buy a larger value of stocks against the money they may not have.

For example, suppose you plan to buy stocks worth ₹3 lakh but you can afford to pay only ₹1 lakh. You can use MTF in such a situation. In this case, the ₹1 lakh that you pay will be the margin, while the balance ₹2 lakh will be the margin trade funding provided by the broker.

MTF is also known by many other names such as margin funding facility, margin trading, pay later, buy now pay later, margin funding facility, etc.

MTF vs loan against securities

MTF is a kind of loan that investors can use to buy shares of their choice. However, it is different from the loan against securities (LAS).

The amount received from LAS can be used for any other purpose and it is issued only by banks and non-banking financial companies (NBFCs) authorised by the Reserve Bank of India to issue such loans.

In contrast, MTF is a financing option provided by stock brokers, and the amount issued through this facility can be used only for buying stocks.

How does the margin trading facility work?

Let's understand with an example.

Imagine you have spotted a company, which you believe is going to give a 10% return in a month and you want to buy shares worth ₹5 lakh of this company. But you have only ₹2 lakh in your brokerage account. In this, case you have two options:

In this situation, if the stock rises by 10% in a month, the total value of your shares becomes ₹2.2 lakh. However, if the stock falls by 10% in a month, the total value of your holding will reduce to ₹1.8 lakh.

In both situations, you only pay the brokerage charges and securities transaction tax (STT) but no additional interest to the broker as you have used your own money to fund the purchase.

In this case, you pay ₹2 lakh while the broker gives the remaining ₹3 lakh. The broker will, however, charge some interest. For easy understanding, let's assume the broker is offering MTF at 15% annual interest.

After a month, if the stock grows by 10%, the total value of your holding will increase by 10% or ₹50,000 to ₹5.5 lakh. However, you will have to pay interest for one month, i.e. 1.25% (15% / 12) of ₹3 lakh to the broker, which is ₹3,750. So the total value of your holding will be ₹5,46,250 (₹5,50,000-₹3750), excluding brokerage charges and STT.

In this case, the value of your holding will fall by ₹50,000 to ₹4,50,000. You will also take an additional hit due to the one-month interest of 1.25% on ₹3 lakh, which is ₹3,750.

So the final value of your holdings in case of a 10% market correction will be ₹4,46,250 (₹4,50,000-₹3,750), excluding brokerage and STT.

Thus, MTF can be highly rewarding if your prediction or estimate of a stock's performance comes true. However, it can lead to heavy losses if the market corrects beyond your expectations.

Key points to keep in mind before using MTF

• Just like shopping with credit cards or BNPL, MTF has some pros and cons. Choose this option if it fits your financial situation and repayment capacity.

• First-time investors should ideally avoid facilities like MTF as they may find it difficult to pick good stocks. MTF may be well-suited for seasoned investors.

• While MTF might give high returns in a short time, it comes with a high risk of heavy losses as well. Ideally, MTF should be used only when you have a very high-conviction stock idea. Using this facility based on random tips and social media hype may lead to losses.

• The return you expect from a stock through MTF should be higher than the rate of interest charged by the broker. For example, if you expect a 10% annual return from a company’s shares but your rate of interest is 15% per annum, you will end up making losses.

• When you buy an MTF stock, you have to pledge it. If you forget to pledge, it will become a fully paid stock and you will asked to repay the full amount.

• When you get a surplus fund in your account, you can use it to free your pledged stocks.

• The MTF funding period and terms and conditions may vary from broker to broker.