How do general obligation bonds work?

General obligation bonds can be issued by states, counties, towns, cities, and other municipal authorities. Jurisdictions often use general obligation bonds to raise funds for projects that will benefit the entire community, but will not generate sufficient direct revenue to support repayment of the debt. These bonds can bridge the gap between the costs of affordable housing projects and the financing they can support through expected rents or home sales. General obligation bonds may be repaid out of the general revenue or through increases in existing taxes. Property taxes are the most common source of financing, but jurisdictions may also levy additional sales, income, and other taxes for this purpose. Because general obligation bonds are secured by tax dollars, they must go on the market through a competitive bidding process in which the broker dealer offering the lowest interest cost wins the bonds. This process assures taxpayers that the municipality is borrowing at the lowest possible rate.

Portland Place, Minneapolis MN -- Photo courtesy of LHB, Inc.

Investors are willing to accept a lower rate because, in most cases, municipal bond interest is exempt from federal tax and can be exempt from state tax if the investor resides in the state issuing the bond. General obligation bonds serve a public purpose and therefore interest on these bonds is exempt from federal tax.

In some states and municipalities, the ability to issue general obligation bonds is restricted by a legal debt limit that determines the maximum allowable bond debt the jurisdiction can have outstanding at any time. For example, the Texas state constitution limits general obligation bond debt to a maximum of five percent of the average revenue from taxes over the past three years. The amount the state can borrow against the general revenue is thus tied to the amount of general revenue the state collects. Many states use the same general approach, though the percentages of revenue used to determine the debt limit vary. Hawaii, for instance, limits general obligation bond debt to 18.5 percent of the general revenue averaged over the past three years.

Learn more about the ways that general obligation bonds differ from other types of government bonds that can be used to support affordable homes.

Click on the links below to learn more about using general obligation bonds to finance affordable homes: How are states and localities using general obligation bonds for affordable homes? How can we build public support for housing bond issues? Click here to view other resources on housing bond issues.