Municipalities such as school and community college districts can finance their project needs using municipal bonds.
Bonds are a debt similar in concept to a homeowner obtaining a mortgage from a bank to purchase a home. The borrower receives upfront proceeds for their home purchase and repays the bank (with interest) over time.
In the mortgage example, several factors will determine the borrowing amount and cost such as credit rating, affordability, home purchase price, and market conditions.
Municipal bonds are similar in that proceeds are received by the municipality upfront and repaid with interest over time.
Typically, there are several other investors
Rather than a single bank though, there are typically several other investors such as mom and pop retail investors, mutual funds, banks, and insurance companies.
Different types of municipal bonds
There are also many different types of municipal bonds. There are long-term financings such as general obligation bonds and short-term financings such as tax and revenue anticipation notes.
The appropriate municipal bond financing is generally a function of what is being financed and how it is being repaid. A municipality’s credit rating, repayment source, proceeds amount and market conditions will determine the borrowing cost.
Many municipal bonds are tax-exempt
Many municipal bonds are also tax-exempt, meaning that some or all of the interest earned by an investor is not subject to income taxes.
Tax-exemption is an important aspect that allows municipalities to borrow at a lower interest cost while allowing investors to deduct their interest earnings.