Definition and Example of Call Loans
Call loans are “callable,” meaning lenders can demand or “call” repayment at any time. They are different from installment loans, which are generally repaid on a predetermined schedule. Stock brokers or brokerage firms typically obtain call loans by borrowing money from financial institutions. These loans are guaranteed by equity securities—usually stocks—which act as collateral for the loan.
- Alternate name: Broker loans, broker overnight loans
One example of a call loan is when a broker borrows money from a financial institution to purchase stock for a client who wants to invest on margin. Buying a security on margin means purchasing it with borrowed funds and using it as collateral. Using an investment like a stock as collateral guarantees the loan and limits the lender’s risk. The broker could continue to borrow money over time, or the lender could demand repayment immediately, perhaps requiring the security that was used to guarantee the loan be sold.
How Do Call Loans Work?
Call loans were popular during the 1920s. Banks or other financial institutions of various sizes would connect with a broker directly or through the money desk at the New York Stock Exchange to loan money. Equities, like stocks, were used as collateral and could be sold if lenders called the loans.
Call loan interest rates, also known as the call loan rate or broker’s rate, were set by the New York Stock Exchange based on the supply and demand of money.
Although they had the ability to do so, lenders seldom demanded immediate repayment of call loans. Instead, the loans rolled over day-to-day so brokers and investors could continue to use the borrowed funds to stay invested in the market.
Since so many financial institutions engaged in call loans, borrowers whose loans were called generally didn’t have trouble finding another lender to loan them money. Then they would use the new loan to pay off the original lender who had called the loan.
Today, call loans are often used to help to increase stock exchanges’ liquidity. Brokers can use call loans to settle daily stock transactions, or to borrow money so investors can purchase stocks on margin. Investors buy on margin to increase their purchasing power; however, this practice can be risky because it exposes the investor to potential losses. If the stock price drops, not only does the investor lose money due to the decline in value, they also have to sell their investment at a loss to generate the funds needed to repay the lender.
It’s rare for lenders to require call loans to be repaid on demand. In fact, it’s common for call loans to be rolled over daily. For this reason, call loans are also known as broker loans or broker overnight loans.
If a banking crisis were to occur, however, banks without sufficient cash reserves may need to call in their call loans. This could make the problem worse, because forcing brokerage firms or brokers to sell stocks quickly to repay their loans could cause stock prices to plummet.
Alternatives to Call Loans
Although individual investors can access call loans, they are only typically available for a specific purpose—buying investments on margin. In addition, calls loans are made primarily to brokers and brokerage houses.
If you need to borrow money, a personal loan like an installment or revolving loan would probably make more sense. You can find secured installment loans, meaning they can be backed by collateral. Or they may be unsecured, which means you don’t have to put up any assets to guarantee the loan. Unlike call loans, your lender may not be able to ask you to repay an installment loan on demand. Generally, you’ll make a predetermined number of payments on a set schedule.
For example, after taking out a personal loan, your lender may require you to pay $500 per month for six years. You’ll also likely pay interest on the loan, although the rate you pay may depend on the lender and your credit score and history.
Revolving accounts are another type of personal loan and may include credit cards or lines of credit. These loans can also be secured or unsecured. You’re usually required to make minimum monthly payments on a revolving account, but again, lenders don’t typically have the ability to demand immediate repayment of the debt like they do with call loans.
- Call loans are typically used by stock brokers or brokerage firms that borrow the money for the purpose of settling stock transactions or purchasing investments on margin for clients.
- Financial institutions such as domestic and foreign banks make call loans.
- Lenders can “call” or demand repayment of the loan at any time.
- Call loans are loans backed guaranteed by securities, usually stocks.
- The use of call loans gained popularity during the 1920s.