The first question you may be asking yourself is what exactly is a Municipal Bond? The Dictionary defines a municipal bond as “a bond issued by a state, county, city, or town, or by a state authority or agency to finance projects.” When someone purchases a municipal bond, the purchaser is lending money to the issuer, which is exchanged for interest payments that are set over an agreed period of time. At the end of this time frame, the bond will reach its date of maturity and the whole amount of the original investment is given back to the buyer.
Municipal bonds are issued with both tax-exempt and taxable formats, but the tax-exempt bonds tend to be the most popular. The reason is because these bonds generate income for the buyers that is exempted from being taxed by the federal government, and most of the time, the local and city taxes of their states. To help break down the specific tax laws in a buyer’s state and helping to navigate the AMT (alternative minimum tax), many investors consult with a tax professional before taking the steps towards purchasing a bond.
Municipal bonds are broken down into two different types; revenue bonds and general obligations. The type of bond is based on the type of principal repayment and their interest payments. In these categories, the bond can be structured in a variety of ways with different risk levels, benefits and treatments. For example, a bond may not always be tax exempted by one body of government and tax exempted by the other. Due to all the variety of factors, it’s extremely important to look at all aspects of each individual bond. So what is the difference between the two bonds you may be asking yourself?
General obligation bonds are issued to raise money immediately to cover expenses. They are issued by a governing body but do not get back by revenues that are generated from a specific property. Many are payable from general funds but often supported by property taxes that have been dedicated. Often a general obligation means that seller has reigned authority to tax residents of the specific municipal to raise money to issue to the bondholder. However, there are expectations that they do not have the authority to tax residents as well.
Revenue bonds are issued to help pay for infrastructure projects and supported by the funds raised during the duration of them. There are about three sellers of revenue bonds in general: Private-Sector Corporations, Entities that give a Public Service and Nonprofit Organizations. A conduit issuer can occur rarely when the municipality issues bonds in that manner.
These are the two basic and most common bonds but not the only ones. To learn more about the different types of bonds, visit Fidelity’s website here.