Bondholders receive interest for the bonds that they purchase -- not dividends. Because bondholders are lending money to entities when they purchase bonds, these interest payments resemble the interest that homeowners pay on their mortgages or that credit card owners pay credit card companies on unpaid balances. The interest is the cost that the bond issuers must pay you, in exchange for the benefit you provide in loaning them money.
Bond Interest Payments
Issuers of bonds include a range of entities, such as municipal governments, businesses and federal agencies. When an entity chooses to issue a bond, it typically offers an annual rate of interest that it will pay to bondholders during the length of the bond. This rate is called the coupon rate. The interest payments often are scheduled for regular intervals until the bond matures. Typically, the payments are made semiannually. Maturity is the set length of time that the bondholder will hold the bond. When a bond matures, the issuer of the bond repays the principal that bondholders paid to purchase their bonds.
Although semiannual interest payments made until a scheduled date of maturity are typical for bonds, bond issuers pay interest in other ways as well. For instance, some bonds make interest payments monthly or quarterly. Zero-coupon bonds, such as U.S. savings bonds, do not make scheduled interest payments. Instead, the bond issuer pays all of the accumulated interest at the time that the bond matures, along with the principal. A callable bond features regular interest payments, but the issuer has the option of repaying the bond early at a set price.
Interest Rate Differences
The interest rates that bonds pay to bondholders vary based on the risk involved in the investment. When a bond carries a relatively high risk of default, which means there's a risk that the bond issuer will be unable to pay back investors' principal, then the bond must pay a relatively high interest rate to investors to appeal to them with greater potential rewards. For instance, bonds that federal entities issue tend to carry low interest rates because they have the backing of the federal government and have virtually no risk of default.
Dividends are payments made to shareholders of a stock for being partial owners in a company. The payments are typically made based on the earnings and profits of the company. In contrast, bondholders receive interest payments because they are serving as lenders. Like interest payments, however, dividend payments typically are regularly scheduled payments made to investors. Interest payments are standard for bonds, but some stocks choose not to pay dividends to shareholders. Instead, the companies reinvest the earnings into their operations and growth.