A government bond is a loan you give to a government, and the government pays you back with interest

When you buy a government bond, you are lending money to a federal, state, or local government. The government promises to pay you back the full amount on a specific date — called the maturity date — and to pay you interest along the way. You are not buying a piece of the government or a share of its future earnings. You are straightforward a creditor, like a bank that lends money to a business.

The U.S. federal government issues bonds to raise money for spending that exceeds tax revenue. States and cities issue bonds to pay for roads, schools, water systems, and other infrastructure. When you hold a bond, you receive regular interest payments — usually twice a year — until the bond matures and you get your principal back.

Bonds are different from stocks. A stock makes you a partial owner of a company and its profits. A bond makes you a lender with a fixed repayment schedule, regardless of whether the government or company prospers or struggles.

Key Takeaways

  • A government bond is a debt instrument where you lend money to a government and receive interest payments until the bond matures.
  • Federal bonds are issued by the U.S. Treasury in three main forms: Treasury bills (under one year), Treasury notes (2 to 10 years), and Treasury bonds (20 to 30 years).
  • Interest from federal Treasury bonds is taxed by the federal government but exempt from state and local income taxes.
  • Bond prices move in the opposite direction of interest rates: when rates rise, existing bond prices fall, and when rates fall, existing bond prices rise.
  • You can buy Treasury bonds directly from TreasuryDirect.gov or through a bank or broker, and you can sell them before maturity on the secondary market.

The three main types of federal government bonds and how long you hold them

The U.S. Treasury issues three categories of bonds, separated by how long until they mature. Treasury bills mature in less than one year — typically 4 weeks, 13 weeks, 26 weeks, or 52 weeks. You buy them at a discount to their face value and receive the full face value at maturity; the difference is your interest. Treasury bills are the shortest-term option and carry the lowest interest rate.

Treasury notes mature in 2, 3, 5, 7, or 10 years. You receive interest payments twice a year, and at maturity you get your principal back. Treasury notes offer higher interest rates than bills because you are lending the money for longer.

Treasury bonds mature in 20 or 30 years. They also pay interest twice a year. Because you are committing your money for decades, Treasury bonds typically offer the highest interest rates of the three types. All three are backed by the full faith and credit of the U.S. government, meaning the government has never defaulted on a Treasury bond.

How interest rates and bond prices move in opposite directions

When you first buy a bond, its interest rate — called the coupon rate — is fixed for the life of the bond. If you hold it until maturity, the rate never changes and you know exactly what you will receive. But if you sell the bond before it matures, its price on the secondary market moves based on what new bonds are paying.

When new Treasury bonds are issued with higher interest rates, existing bonds with lower rates become less attractive. To sell an older bond in this environment, you must lower its price so that the total return to the buyer matches what they could get from a new bond. The opposite happens when interest rates fall: existing bonds with higher rates become more valuable, and their prices rise.

This inverse relationship between rates and prices matters only if you plan to sell before maturity. If you hold until the bond matures, you receive the full face value regardless of what happened to the price in between.

Tax treatment of federal, state, and municipal bonds

Interest from federal Treasury bonds is subject to federal income tax. You report it on your tax return and pay tax at your ordinary income tax rate. However, interest from Treasury bonds is exempt from state and local income taxes. This can make Treasury bonds more attractive in high-tax states, because you keep more of what you earn.

State and local government bonds — called municipal bonds — work differently. Interest from municipal bonds is typically exempt from federal income tax, and if you buy a bond issued by your own state, the interest is usually exempt from that state's income tax as well. This tax advantage makes municipal bonds attractive to people in high federal or state tax brackets, even though they often pay lower interest rates than Treasury bonds.

Corporate bonds, by contrast, are fully taxable at federal, state, and local levels.

Where to buy government bonds and how to sell them

You can buy Treasury bonds directly from the U.S. government through TreasuryDirect.gov, a free online platform run by the Bureau of the Fiscal Service. You create an account, fund it with money from a bank account, and bid on bonds during Treasury auctions. There are no fees, and you can hold bonds in TreasuryDirect until they mature.

You can also buy Treasury bonds through a bank, brokerage firm, or investment advisor. These intermediaries charge a fee or markup, but they may offer convenience or information. Some people prefer this route if they want to buy bonds outside of auction dates or if they want a broker to manage the purchase.

If you need to sell a Treasury bond before it matures, you cannot sell it back to the government. Instead, you sell it on the secondary market through a broker. The price you receive depends on current interest rates and market conditions. TreasuryDirect does not allow sales of bonds held there, so if you think you might need to sell early, buying through a broker may be a better choice.

The difference between savings bonds and Treasury bonds

Savings bonds — specifically Series EE and Series I bonds — are a different product from Treasury bonds, though they are also issued by the U.S. Treasury. Savings bonds are designed for individual savers and cannot be sold on a secondary market. You buy them at face value (or at a discount for Series EE), hold them, and cash them in when you need the money. Series I bonds adjust their interest rate every six months based on inflation, while Series EE bonds pay a fixed rate.

Treasury bonds, by contrast, are traded actively on the secondary market and are held by institutions, investors, and individuals. The interest rates are set at auction and do not adjust. If you want to sell before maturity, you can only do so with Treasury bonds, not with savings bonds.

Why governments issue bonds and what happens to the money

Governments issue bonds when they need to spend more money than they collect in taxes or other revenue. The federal government uses bond proceeds to pay for defense, Social Security, Medicare, infrastructure, and other programs. States and cities use bond proceeds to build schools, highways, water treatment plants, and public buildings.

When you buy a bond, your money goes to the government, not to a company or investment fund. The government then spends that money on whatever it issued the bond to finance. You are not investing in a project or business; you are financing government operations or specific public works.

The government repays the bond from its general revenue — taxes, fees, and other income. If a government cannot repay, it defaults. The U.S. federal government has never defaulted on Treasury bonds. State and local governments rarely default, but it has happened; the city of Detroit, for example, defaulted on some of its bonds during its 2013 bankruptcy.

Frequently Asked Questions

Can I lose money on a government bond?

If you hold a bond until maturity, you receive the full face value and cannot lose money on the principal. However, if you sell before maturity and interest rates have risen, the bond's market price will be lower than what you paid, and you will realize a loss. You also lose purchasing power if inflation exceeds the bond's interest rate, meaning your money buys less when you get it back.

What is the difference between a bond and a CD?

A certificate of deposit (CD) is issued by a bank and insured by the FDIC up to $250,000. A bond is issued by a government or corporation and is not FDIC-insured. CDs typically have shorter terms and lower interest rates than bonds. Both pay fixed interest, but bonds can be sold before maturity on a secondary market, while CDs usually cannot.

How much money do I need to buy a Treasury bond?

Through TreasuryDirect, the minimum purchase is $100, and you can buy in $100 increments. Through a broker, minimums vary but are often $1,000 or higher. Some brokers have no minimum if you are buying an existing bond on the secondary market.

Do I have to hold a bond until it matures?

No. If you own a Treasury bond through a broker or TreasuryDirect account that allows sales, you can sell it on the secondary market at any time. The price you receive depends on current interest rates and market conditions. Savings bonds cannot be sold on the secondary market and must be held or cashed in through the issuer.

What happens if the government defaults on a bond?

If a government defaults, bondholders typically recover some portion of their money through a restructuring or bankruptcy process, but not the full amount. The U.S. federal government has never defaulted. State and local defaults are rare but have occurred; bondholders in those cases usually recover a percentage of their principal over time.