Municipal bonds are loans investors make to local governments. They are issue by cities, states, counties, or other local governments. For that reason, interest they pay on bonds is tax-free. Municipal bonds are securities. That means original owner may sell them to other investors on secondary market. See Taxable municipal bonds for more details
What is municipal bond?
Municipal bonds known as munis. These bond issues to raise capital for their day-to-day activities. And for specific projects that they might be undertaking to develop local infrastructure. Like roads sewerage, hospitals. All Municipal bonds not offer income exempt both federal and state taxes. See Risks of Investing in Bonds
And Interest on municipal bonds is exempt from federal income tax. Thus interest may also be exempt from state and local taxes if you live in state where bond is issue. But interest rate for municipal bonds is lower than on taxable fixed-income securities. Such as corporate bonds. Thus price can change even though interest rate never does. These bonds usually pay for revenue generating projects.
Types of Municipal bonds
Most important types to know are general obligation bonds and revenue bonds. And difference between these two types of bonds. It is source of revenue used to make interest and principal payments. Below are two basic types of municipal securities.
General obligation bonds
General obligation bonds also know GO bonds. That is secure by issuers taxing power. This means that issuing authority can use its power to enact future taxes as security of bond. In other words, municipal issuer can make interest and principal payments any source of revenue.
Such as tax revenues, fees, or issuance of new securities. That is back by full faith and credit of issuer with no specific project. And which has power of tax residents to pay bondholders. Ofen, bonds are also voter approved. They are issue by states, cities or counties and not secure by any assets.
Principal and interest are secure by revenues from specific project source. These bonds are not backed by government taxing power. Public projects finance by revenue bonds include toll roads, bridges, airports. Additionally like water and sewage treatment facilities, hospitals and subsidized housing.
Many of these bonds are issue by special authorities. Some revenue bonds are “non-recourse”. That means if revenue flow dries up. Then bondholders do not have claim on underlying revenue source.
Also, municipal borrowers sometimes issue bonds on behalf of private entities. Such as non-profit colleges or hospitals. These “conduit” borrowers agree to repay issuer. Who pays interest and principal on bonds.
In cases, conduit borrower fails to make payment. Then issuer is not need to pay bondholders. If revenue sources dry up municipality do not have to pay. And third types of bonds are making on behalf of private groups with public purpose.
How to invest in Municipal bonds
There are two ways to invest in municipal bonds. You can buy bonds from municipality through their bank or broker. This method offers you to comfort of knowing what bonds they own within their portfolio. Such as general obligation, revenue or assessment bonds.
Second way to invest in municipal bonds is municipal bond fund. This method offer instant diversify across hundred of municipal bonds. Which can reduce risk for you. Another advantage is increase liquidity available via bond funds. Funds shares can sell at any time. So you will have no problem unloading their bonds for any reason.
Finally, see municipal bonds risk. Also see junk bonds advantages and disadvantages. So you can check savings bonds drawbacks. For more details see bond interest tax rate. Thus see High Yield Municipal Bonds. Check Types of Government Bonds