Difference Between Bonds & Bank Loans

Written by ciaran john
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Bonds and bank loans are both forms of debt instruments. A creditor lends money in the form of the debt instrument to a borrower. The borrower repays the debt with interest over a specified period of time. Most bonds are not held to duration by the original lender and are sold on the secondary market. Most banks loans are held to duration with the exception of mortgages, which are often packaged together in bundles from which bonds are made. Mortgage bonds are sold on the secondary market.

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Types

The major types of bonds are government, mortgage backed, municipal and corporate bonds. The federal government issues three main types of bonds: treasury bonds, treasury notes and treasury bills. They are sold on the primary and secondary markets. I-bonds and EE bonds are not sold on the secondary markets, but buyers can redeem them at any time. Mortgage backed bonds are rated based on the creditworthiness of underlying mortgages. Corporations and municipalities also issue bonds that are sold on primary and secondary markets.

Banks offer clients mortgages, variable rate home equity lines and fixed rate home equity loans. Banks also write vehicle loans and commercial loans.

Function

Governments issue bonds to pay for services and infrastructure costs such as schools and roads. Bondholders are paid with money raised through taxation. Government revenue bonds fund utilities, and profits are used to pay bondholders. Corporations use bonds to finance expansions and development of new products.

Banks issue loans to generate profits that cover operating expenses, technological upgrades, acquisitions and enable them to pay dividends to shareholders. Selling mortgage backed bonds also creates revenue.

Time Frame

Treasury bills have durations that range from a few days to a year. Treasury notes last for two, three, five, seven or 10 years and Treasury bonds last up to 30 years. Corporate and municipal bonds have durations of between five and 30 years.

Standard mortgage terms are 15 and 30 years. Home loans last between 10 and 30 years, and car loans usually have terms no longer than six years. Business loans often have annually renewable terms but maximum durations of 10 or 20 years.

Considerations

Bond holders are creditors, and shareholders are owners. When a company files bankruptcy, after taxes and wages have been settled, creditors are paid before shareholders. In most bankruptcies, shareholders receive little or nothing, whereas bond holders often receive the money owed to them even if it takes several years to receive it.

Unlike bonds, most bank loans have tangible collateral than banks can seize if homeowners or car owners default on loans. Collateral means banks assume less risk than long-term bond holders even though rates on mortgages are usually higher than on 30 year bonds.

Warning

Many government and corporate bonds are callable, which means the issuing entity can pay off bondholders early. This impacts people who rely on bond interest for income. Bonds are usually called in during periods with falling rates, which makes it hard for bondholders to find news sources of comparable income.

Banks cannot call in mortgages early unless borrowers default. People who buy bonds tied to mortgages run the risk of the mortgage borrowers choosing to payoff the loans early, in which case the bonds are effectively called in.

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