The cost of long term financing is usually higher than cost of short term financing and the relationship between long term and short term rates is usually described by use of a yield curve. Long term financing entails that the amount acquired under this mode of financing remains engaged for a longer period of time and is unavailable for reinvestment of other purposes to the lending institution or individual. Short term financing on the other hand is acquired for a shorter period of time and is reimbursed to the financing party after a shorter period and the financier can reinvest the returned amount in other profitable options.
This is one of the main reasons of higher interest or financing rates on long term loans and financing options and lower interest or financing rates on short term financing options. The long term, rate is higher as the amount remains tied up and is unavailable to the lending party. Short term finances lower interest rates due to a shorter payback period. The second reason for this difference in rates and cost of long term and short term financing is the level of risk involved. The credit risk for the lender or investor involved in long term financing is much higher than short term financing as any changes in the economy may affect the rate of interests and loans. These changes may include variations and changes in market, international interest rates, inflation and other economic elements may affect investments and loans significantly.
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