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- What are Municipal Bonds
What are Municipal Bonds
As part of an overall financial strategy, when cities need funds to finance projects that serve a public purpose, they will issue municipal bonds as a way to fund these projects. Municipal bonds are debt securities issued by these organizations to bondholders. In other words, the bondholders are lending the City funds that are expected to be paid back at face value at a certain date, plus periodic interest payments. An extra benefit of this interest is that it is usually exempt from federal income taxes and sometimes local and state taxes as well. This interest is usually paid every six months until the date of maturity, when the face value of the bond is paid back to the bondholder.
The City uses debt to manage major capital investments that are needed within the City, such as street and drainage improvements, municipal facilities, parks and utility systems. The bonds that the City issues are a tool- similar to how a individuals use credit to finance capital purchases such as a home, vehicle or other major purchase. Debt service payments are made twice per year, with interest paid at both payments and principal payments once per year- payments are usually due in in February and August. The funding source for each payment depends on the type of bond that was issued. See Types of Bonds for further explanation.
Issuing bonds help cities to ensure intergenerational equity by spreading payments for assets and infrastructure over their useful lives. Intergenerational equity relates to equity between present and future generations and considers distribution of resources or burdens between generations. This helps to ensure that residents today are not responsible for paying for the full cost of a project that will continue to benefit residents for decades in the future.
Financing projects through bonds is equivalent to taking out a mortgage to purchase a home that you intend to live in for 20-30 years, rather than emptying your savings to pay cash for it. The City has tools to manage its debt load- such as structuring the debt with equal principal payments over a 20 year period and timing bond sales to match up with when the funds are needed for projects.