Loans come in many varieties. Two of the chief defining characteristics of a loan are its interest rate--how much interest the borrower is required to pay on the principal of the loan--and its term--the length of time that the borrower has to pay the loan back. While in some cases the interest rate for short-term loans is higher than for long-term loans, this is not always the case.
Nearly all loans carry some rate of interest. This rate of interest is typically set by the lender. The lender will set the rate of interest low enough so that it will attract borrowers, but high enough that he will be properly compensated. To determine proper compensation, the lender must consider a number of factors, including the cost of issuing the loan, the rate of inflation and the risk that he carries in issuing the loan.
According to the financial reference website the Financial Pipeline, there is no direct correlation between the length of a loan and the interest rate that the loan carries. While some short-term loans are riskier than long-term loans, the short duration of the loan is not a factor in the risk. In fact, long-term loans may be considered riskier on the whole, as they demand the party paying them off to remain financially solvent for a longer period of time.
Short-Term vs. Long-Term
The terms "short term" and "long term" are relative rather than definitive terms. An interest rate may be considered a "long-term" rate for certain types of loans and a "short-term" rate for others. For example, while the interest rate for a five-year loan may be considered quite long if the loan is issued for an unsecured loan, this would be a very short loan when applied to a large, secured loan, such as a mortgage.
While short-term loans often command higher rates of interest, this is not necessarily because the loan is short term but because a specific type of short-term loan happens to be risky. For example, payday loans are short-term loans that typically carry a huge rate of interest. However, the interest rate is not high because the loans are short term but because the people who take out payday loans are considered to be at high risk of default.
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