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Both bonds and loans provide a way to borrow money, but there are some key differences between the two, including who supplies the funding, and how they’re structured and regulated.
Read on for a look at how each option works, the pros and cons of personal loans and bonds, and when it might make sense to choose a loan vs. a bond.
Key Points
• Bonds and loans are both financing options that businesses and other entities may use to get the funding they need.
• With a loan, the funding typically comes from a bank, credit union, or other lender, and the borrower agrees to make monthly payments with interest for a set period of time.
• With a bond, the funding comes from multiple investors who agree to receive interest payments from the bond issuer on a set schedule and to be repaid their principal in full when the bond matures.
• For a business deciding between bond vs. loan, the right option may depend on the company’s size, timeline, goals, and other factors.
What Is a Bond?
A bond is a type of debt instrument that enables a business or government to raise money by borrowing from investors instead of getting a loan from a financial institution. Is a bond a loan? Yes, a bond is a type of loan — but it may not be what the average person thinks of when they think of a loan.
A business might use bonds to fund an expansion, to buy property or equipment, or to hire more employees. Similarly, governments often use bonds to help fund much-needed infrastructure projects, such as roads, parks, or schools.
Investors who purchase a bond receive interest payments at agreed-upon intervals during the bond’s term (or for as long as they hold the bond) at the bond’s specified interest rate. When the bond matures, the company repays the bond’s face value to the bondholder.
Types of Bonds
There are three main types of bonds:
• Corporate bonds are issued by private and public corporations, and the interest rate and payment schedule are set by the company. (Typically, investors receive interest payments twice a year; however, some issuers may offer annual, quarterly, or monthly payments.) Corporate bonds generally offer higher yields than government bonds because they carry more risk. It’s up to investors to do their due diligence by looking at the issuer’s credit rating and other factors before making a purchase.
• Municipal bonds, or “munis,” are issued by states, cities, counties, and other local government entities. There are different types of munis, including general obligation bonds, revenue bonds, and conduit bonds, and their safety and return to investors depends on the reliability of the issuing entity. Because the interest they pay is tax-exempt, munis can be an appealing investment, especially for investors in a high tax bracket.
• U.S. Treasuries are considered a particularly safe investment because they’re issued by the U.S. Treasury Department and carry “the full faith and credit” of the U.S. government. Treasury securities (bills, notes, and bonds) come in affordable increments, can provide predictable income, and offer varying maturity options.
If you’re thinking about investing and you’re wondering how to buy bonds, it depends on what type you’re interested in. An individual investor can buy Treasury bonds directly from the U.S. government through the Treasury Direct website, or through an account at a brokerage firm or commercial bank. Corporate and municipal bonds can be purchased through full-service, discount, or online brokerage firms, and through investment and commercial banks.
“A bond is basically loaning someone—a government, company, or municipality—money. Bonds can provide a steady stream of income, which includes interest payments and the initial investment. However, bonds are riskier than cash. Bond issuers can default, and the yields in the long-term aren’t as high as other investments,” says Brian Walsh, CFP® and Head of Advice & Planning at SoFi.
To better understand what is the difference between a bond and a loan, let’s take a closer look at how typical loans work.
What Is a Loan?
Usually when a person or company needs an infusion of cash, they will go to a bank, credit union, online lender, or other source for a loan. The borrower agrees to repay the borrowed amount (called the principal), plus interest, over a specified loan term.
The amount of interest a person or business must pay, which is usually expressed as a percentage, is typically tied to their creditworthiness, the length of the loan, the type of loan, and current market rates. Generally, the lower the risk for the lender, the lower the personal loan interest rate. And interest rates may be fixed or variable.
Recommended: Personal Loan APR vs. Interest Rate
Types of Loans
Most Americans will take out some type of loan during their lifetime. Some common loans include:
• Personal loans These can be used for just about anything, including debt consolidation, home renovations, or wedding costs. Most personal loans are unsecured and have a fixed interest rate.
• Auto loans These loans are typically secured with the car that’s being purchased. If the borrower doesn’t make the payments, the lender can repossess the car. This kind of loan has a fixed interest rate and terms typically range from three to eight years.
• Student loans The government and private lenders provide student loans. Private student loans come with much fewer protections and benefits, but if you have a good credit rating, you may qualify for a competitive interest rate with a private lender. And a private loan may help fill the gap between what you need and what the government will lend you.
• Mortgage loans Home loans are secured by the property you purchase. Homeowners can get a government-backed mortgage or a conventional mortgage from a bank, credit union, or other lender.
• Business loans There are several types of business loans to help business owners with everything from startup costs to expansion plans. Some come from private lenders and others are backed by the Small Business Administration (SBA), which are issued by lenders that meet the agency’s guidelines.
Recommended: What Are the Different Types of Debt?
Bonds vs. Loans: Key Differences
Bonds and loans can both be useful tools for those who need money. But there are some loan vs. bond differences to be aware of, including:
Who Provides the Funding
• Bonds are issued by corporations and governments to investors who choose to lend them money. Multiple investors — individuals and institutions — may opt to temporarily own a piece of corporate or government debt in exchange for interest payments.
• Loans are issued by a lender (typically a bank or credit union) to a single borrower or entity.
How Interest and Repayment Work
• Bonds usually pay a fixed interest rate, called a coupon, at regular intervals (typically twice a year) until the bond matures. At that point, the investor’s full principal amount is returned.
• Most loans — like personal and small business loans — are installment loans. Payments are made on a schedule, with a portion of the borrower’s payment going toward the principal amount owed and a portion going toward the interest. The full amount is expected to be repaid by the end of the loan’s term. Borrowers can research average personal loan interest rates to see how the rate they are being offered compares.
Tradability and Liquidity
• Bonds can be traded in financial markets. If you invest in a bond and decide you need your money back before it matures, you can sell it to another investor. The bond’s price may not be the same as what you paid, depending on current interest rates and the issuer’s standing — but bonds do offer liquidity.
• Loans are not easy to trade. The responsibility to repay the loan typically remains with the borrower for the life of the loan.
How They’re Used
• Bonds are often used by corporations and governments for large-scale funding.
• Loans are generally used for personal or business purposes.
Regulatory Requirements
• A public bond offer must be registered with the Securities and Exchange Commission (SEC), and the issuing company must periodically disclose sensitive details about its finances and operations.
• A bank loan does not carry the same disclosure requirements for the lender or borrower, so it can provide more privacy. It can also take less time and effort to set up.
Pros and Cons of Bonds vs. Loans
As with any financial decision, there are advantages and disadvantages to consider when looking at bonds vs. loans.
Pros and Cons of Bonds for Businesses
• Pros: The interest rates companies pay their bond investors are usually less than the interest rate they’d have to pay with a bank loan. Issuers can also set their own terms, so they can tailor the bond offer to meet their specific needs.
• Cons: Interest rates can depend on the bond issuer’s credit rating, so new or smaller businesses may find it more challenging to put together a bond offer that’s attractive to investors but also meets their company’s needs. There also can be ongoing fees and regulatory reports to consider.
Pros and Cons of Loans for Businesses
• Pros: A loan may be a more practical option for a large company’s short-term needs, or at any time for a new or small business. The funding can be more predictable, which can make budgeting easier. And a loan may provide faster funding, as it can take some time to package and sell a bond issuance.
• Cons: Using a loan for funding may be more expensive overall if lenders’ interest rates are high. There’s also less liquidity with a loan, since you can’t sell it and get out of it as easily as a bond. And if borrowers default on a secured loan, they may lose their collateral.
The Takeaway
Both bonds and loans provide a way to borrow money — and interest rates and creditworthiness can play a role in how each one works. But there are some important differences between a loan and a bond.
If you’re a small business owner, for example, you may not be ready or able to issue corporate bonds, but your company might benefit from an affordable personal loan or small business loan.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.
FAQ
Is a bond considered a form of a loan?
Yes, a bond can be considered a type of loan. When investors purchase a bond, they are lending money to the issuer. In exchange, the issuer agrees to pay back the bond’s face value when the bond matures and to make periodic interest payments during the bond’s term to maturity.
Can an individual investor buy bonds directly?
An individual investor can buy Treasury bonds directly from the U.S. government through the Treasury Direct website, or through an account at a brokerage firm or commercial bank. Corporate and municipal bonds can be purchased through full-service, discount, or online brokerage firms, and through investment and commercial banks.
Which typically has a lower interest rate, a bond or a loan?
Bonds generally are offered with a lower interest rate than loans. But creditworthiness and other factors can influence the rate for both bonds and loans.
How does creditworthiness affect bonds and loans differently?
Companies with a strong credit rating can issue bonds at lower interest rates, making it a cost-effective way to raise capital — and easier to attract investors. Individuals and companies can also use their creditworthiness to save money on a loan, by qualifying for a lower interest rate and other favorable terms.
Are bonds or loans better for a small business?
A small business may not be ready for the costs or disclosure requirements required to issue bonds — so a bank loan may be the better choice. It also may be more manageable for a smaller company to make predictable monthly payments on a loan instead of waiting to repay multiple investors their bonds’ full face value amount when their bonds mature.
photo credit: iStock/Szepy
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