Lesson 5 of 20 · 7 min
The maintenance rate, and how it differs from the advance rate
One number decides what you can borrow. A different, lower number decides when you get called.
This is the single most commonly conflated pair in the whole subject, and separating them is worth the effort.
The advance rate is an origination number. It answers: given this collateral, how much may be drawn? The maintenance rate is a survival number. It answers: given this loan, how far may the collateral fall before the lender requires action? They are usually different percentages, and the space between them is the only cushion you have.
Work it through concretely. Suppose the advance rate is 50 percent and the maintenance requirement says the loan may not exceed 70 percent of market value. You pledge $400,000 and draw the maximum $200,000. Your loan is now 50 percent of market value. The call comes when the loan reaches 70 percent of market value, which happens when market value falls to $285,714. That is a 28.6 percent decline. That number — not the advance rate — is your actual cushion.
Two failure modes follow. First, people read the advance rate as their safety margin, which overstates the cushion badly. Second, people draw the full amount available and treat the resulting position as normal, when in fact drawing the maximum sets the cushion at its minimum by definition. Nothing has gone wrong yet; the room has simply been spent.
The advance rate is about the day you sign. The maintenance rate is about every day after.
Key terms
- Advance rate
- The percentage of collateral value that may be borrowed at the outset.
- Maintenance requirement
- The threshold at which the lender may demand more collateral or repayment. Often expressed as a maximum loan-to-value.
- Cushion
- The decline in collateral value you can absorb before the maintenance threshold is breached. A consequence of both rates and how much you drew.
Worked example
Turning two rates into one number that matters
Advance rate 50%, maintenance threshold 70% of market value, $400,000 pledged, full draw.
- Maximum draw
- $200,000
- Loan-to-value at signing
- 50%
- Market value at which LTV hits 70%
- $285,714
- Decline you can absorb
- 28.6%
$400,000 × 50%
$200,000 ÷ 0.70
($400,000 − $285,714) ÷ $400,000
The advance rate said 50%. The real answer to 'how far can this fall' was 28.6%. Only one of those is worth memorising.
Check yourself
Advance rate 60%, maintenance threshold 75% of market value. You pledge $500,000 and draw the full amount. How far can the portfolio fall before a call?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.