Housing Bonds

What Are Housing Bonds?

Housing bonds are debt securities, a variation of municipal revenue bonds, issued by state or local governments to raise money for affordable housing development projects.

Understanding Housing Bonds

State and local governments issue housing bonds to finance the construction or rehabilitation of affordable housing. In addition to repaying the bond principal, the state or locality must pay interest on the money it borrows. Housing bonds sometimes require voter approval and can either be short- or long-term issuances.

A municipal authority may issue debt in the form of bonds to raise capital to finance projects. The two types of municipal bonds are general obligation (GO) bonds and revenue bonds. The interest payment and principal repayment of general obligation bonds are funded from the state or local government's financial coffers. These bonds are backed by the full faith and credit of the municipal government, which may have the authority to increase taxes in order to fulfill its payment obligations on the GO bond. Meanwhile, payment obligations on a revenue bond are backed by the projected revenue stream of the project for which the bond was issued. A housing bond is one type of a revenue bond.

As private activity bonds (PABs), housing bonds can be issued on behalf of qualified profit and nonprofit developers to finance low-income multifamily and senior housing projects. Also, the proceeds from housing bonds may also be issued to provide low-cost mortgage financing to low-income families or individuals so they can purchase a home. 

Requirements for Housing Bonds

Mortgages provided through housing bonds are restricted to first-time homebuyers who earn no more than the area median income. Furthermore, the price of a home purchased with a housing bond mortgage is limited to 90% of the average area purchase price.

Housing bonds typically have low interest rates and can be issued as either a fixed or variable-rate demand obligation (VRDO). The principal and interest payments to bondholders are made from pledged mortgage repayments and investment earnings. The repayments made on mortgages by borrowers are collected by the trustee of the housing bond who invests the funds in short-term investments until the scheduled time to pay interest to bondholders. In effect, payment on housing bonds is backed by the timely and consistent interest payment and principal repayment of the underlying mortgages by borrowers.

Benefits of Housing Bonds

Housing bonds are beneficial to the state as well as to private investors. On the one hand, the government gains access to a large amount of cheap financing. On the other, the tax advantages offered by housing bonds are highly attractive to lenders in the upper tax brackets. 

For investors, the interest paid by housing bonds is exempt from federal and, at times, state income tax. The higher the marginal tax rate, the more valuable a housing revenue bond's tax exemption. Although investors subject to the alternative minimum tax (AMT) may be subject to taxes, the exemption means that investors in high federal-tax brackets benefit from revenue bonds and other municipal bonds. This tax exemption helps to compensate for the bonds' low interest rate.

Federal low-income housing tax credits are another source of capital that may be used instead of, or in addition to, housing bonds in order to finance affordable housing projects. The credits are nonrefundable federal income tax credits for part of the mortgage interest that qualified home buyers pay each year.