Towns use a variety of different ways to generate revenue to sustain the operations and functions that are necessary. Some depend on government grants to supplement revenue deficits to complete special projects, while others work on lines of credit. Municipal bonds are an alternative choice for towns that find themselves with their backs up against the wall. Investors are turning towards this tactic to help out their home-town and turn a small profit in the process. If you’re wondering why a town would issue a bond, here's what our research has revealed.
Why do towns issue municipal bonds?
Towns have operating expenses that continue daily. The revenues generated through payments for water, sewer, and garbage services, fees for building permits, taxes, licensing, along with other fees help to sustain your day to day operations, but they fall short of covering everything. There's a never-ending storm of expenses associated with keeping a town maintained, operational, and safe for its residents. According to Zacks, many towns finish up in the position of needing additional financing for meeting day to day expenses, but there are other reasons for generating extra funding.
Towns use funds generated from bonds to build new structures, to create repairs upon or improve existing buildings, to pay employee wages, to fund special projects, improve roadways, and other vital projects that are expensive for complete. The funds raised through the sale of bonds help cities to accomplish the projects that are essential for the health and welfare of residents. Fundamental essentials most common reasons why towns offer bonds.
What are municipal bonds?
Investor.gov explains what municipal bonds are and just how they work. These bonds are issued by government entities including cities, states, counties, and others, for funding day to day commitments, to improve highways or sewer systems, to construct schools or to finance capital projects. Investors who purchase municipal bonds lend money towards the issuer in exchange for interest payments around the money loaned.
The benefits of purchasing municipal bonds
Investors gain an advantage from purchasing municipal bonds since the investment is exempt from federal income tax. Some of these bonds have an exemption from state and local taxes if the investor is really a legal resident of the state of issue. Municipal bonds may bring in a steady flow of revenue payments for investors by means of interest on the bond for the duration of the life of the bond. The principal of the bond is paid once the bond matures.
What is the term length of municipal bonds?
The length of municipal bonds can vary. There are both short-term and long-term types with maturity dates that may extend from one to three years as much as ten in most cases. Investing in municipal bonds is equal to investing in the quality of life for those who live within the community that benefits from the increase in funding of special improvement projects.
Different kinds of municipal bonds
There are two types of municipal bonds. They are General Obligation bonds and Revenue bonds. Investors purchase General obligation bonds within the faith of the reputation and credit from the issuer. Government entities or municipalities possess the right to tax residents to fulfill bond payment obligations like a form of security. Revenue bonds are backed in the proceeds/revenues generated by the projects they fund. Fundamental essentials riskiest investments of the two. If the revenue bond is listed as a “non-resource” type, bondholders may not file claims on the underlying revenue source if the revenue stream from the project dries up. One particualr revenue bond is one that is issued to fund highways or perhaps a toll bridge with the tolls supporting the repayment of the bonds.
Facts about Municipal bonds
Before you purchase municipal bonds it’s wise to familiarize yourself with the benefits and potential drawbacks. Money points out a few more details about municipal bonds that investors have to know. Both general obligation and revenue bonds are exempt from federal, state, and local taxes if you live in the place where they're issued. The investment duration might be advantageous because these bond issues offer various maturity dates. Some municipal bonds mature in a single year while others may not reach full maturity for up to 38 years, with 10 years being the median duration. Most municipal bonds have a floating interest rate that can fluctuate with the prevailing market rate. Most municipal bonds aren't fixed rates. These investments usually generate interest that's a point lower than US Treasury bonds, but there has been periods when municipal bonds have performed at a point or two higher.
What is really a Zero Coupon Municipal bond?
There is one more type of municipal bond to go over. The Zero Coupon type is a security that unlike others, does not pay the bondholder interest payments through the duration of the life of the bond. Instead, all interest is paid at the time that the bond matures. The repayment with interest rates are made in one lump sum. Another difference with the Zero Coupon Municipal bond is it is taxable. Investors may purchase this kind in preparation for a significant expense for example college for children or the acquisition of a new home. While the lack of tax exemption may initially seem like a downside of the Zero Coupon type, the eye rate on this type of bond is higher to offset taxation. From a good investment strategy point of view, it’s a wash.
Final thoughts
Municipal bonds are good for towns in need of additional funding for special projects or daily operating expenses. Investors have several types to choose from. They are commonly used for diversification of the investment portfolio and provide a relatively low-risk investment. Some offer a good flow of dependable income in the form of interest payments.
