Short vs. Long Term Interest Rates: Differences & Significance

Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

After reading this lesson, you will understand why long-term interest rates are usually higher than short-term interest rates. You will also see some examples of why this makes sense.

Short-Term Interest Rate

Your best friend has just come up to you and is asking to borrow $400 so he can purchase his dream car. He says he will pay you back at the end of the week when he gets paid. What did your friend just do? He just made a short-term loan with you as the lender and him as the borrower. Now, it is up to you to decide whether or not to charge interest. If you do, the interest rate that you charge on a short-term loan is referred to as the short-term interest rate.

Long-Term Interest Rate

Your friends must think you are rich because now another friend also comes up and asks you for $400 to help him pay his rent for the month. He says that he can't pay you back until the following year or maybe even another year after that. This friend has just started his own business, and the business is still not making enough to support him. If you give him the $400, you have given your friend a long-term loan. If you decide to charge your friend interest, the interest rate you charge on this long-term loan is referred to the long-term interest rate.

Differences

The major difference between a short-term interest rate and a long-term interest rate is the length of time it takes for the loan to be paid back. Another difference is that long-term interest rates are usually higher than short-term interest rates. For example, your bank will charge you a lower interest rate on a $10,000 loan that you pay back within 6 months than on the same $10,000 loan but paid back in 5 years.

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