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Sinking Fund – What it is and How it Works

A sinking fund is an account set-up by a municipality to redeem or purchase its bonds prior to maturity. By having a sinking fund, a municipality can reduce its debt load over time, avoiding the need to finance a large lump sum when the bond reaches maturity.  Typically, a municipality is required to put a certain amount in the sinking fund every year, as described by the bond offering statement. Depending on how the sinking fund is set-up, it may be used to purchase bonds on the open market, or by exercising the bond’s call feature. (You can learn more about callable bonds here.)

There is good side and bad side to a sinking fund for bondholders:

  • The good side is that a sinking fund reduces the chance that a municipality will not able to meet their debt obligations, by enforcing fiscal discipline over the term of bond.
  • The bad side is that there is a fairly high chance that your bond will be called before maturity, and you will face re-investment risk (not being able to receive the same interest rate as when you invested in the bond).

 

Super Sinking Fund

When investigating sinking funds, you may also hear about super sinking funds.  A super-sinker is specifically related to single family mortgage revenue bonds.  Funds gathered through the prepayment of mortgages go into the super sinker. Otherwise, a super-sinker operates likes a normal sinking fund.

Learn More

The Safety of State Bonds: A Historical Perspective
Serious Mortgage Delinquencies and In-Foreclosure by State
Types of Bonds
How to tell if a Municipal Bond is Tax Free?
General Obligation Bonds

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David Waring was the founder of LearnBonds.com and has been a major contributor to the extensive library of investing news and information available on the site. Until the launch of Learnbonds.com in late 2011 there was no single site on the internet catering exclusively to the individual bond investor. This was true even though more individuals own stocks than bonds. Learn Bonds was launched to fill that gap.