Short-Term vs. Long-Term Interest Rates: Understanding the Difference

For the saver, investor, cash holder or anyone who relies on fixed-income investments, interest rates are important. It's what people earn on their "safe" money. Interest rates are equally important to those seeking credit. It's what they'll pay to borrow money for a set period in exchange for the promise to return the cash in the future.

The interest rate that a person or organization is paid to lend money or is charged to borrow money depends on a variety of factors, including the term of an investment or loan. Typically, short term-interest rates are lower than long-term rates.

Short-Term Interest Rate

A short-term interest rate, or money market rate, applies to an investment or loan with a maturity of less than a year. Short-term rates apply to financial instruments including Treasury bills, bank certificates of deposit and commercial paper. The Federal Reserve influences the reserves market and the federal funds rate, which has some effect on short-term interest rates.

Long-Term Interest Rate

A long-term interest rate applies to a financial asset with a maturity of one year or longer. Consequently, long-term interest rates apply to bonds, real estate and notes payable. According to the Federal Reserve, the relationship between the Fed's monetary policy actions and long-term rates is weak and variable.

Risk and Interest Rates

When you borrow money or lend money for the short term, your interest rate will be lower than if you borrow or lend money for the long term. The difference between the short- and long-term interest rates is partially attributable to the risk of a short-term investment versus that of a long-term investment. An increase in uncertainty -- risk -- comes with the passage of time.

The risk a lender assumes when it loans cash for a long term is compensated for by the payment of a higher interest rate than what it pays for short-term loans. Consequently, investments with short maturities tend to pay less interest than those with long maturities.