What generally happens to the interest rate when a loan has a longer duration?

When a loan has a longer duration, lenders typically demand a higher interest rate. This is primarily due to the increased risk associated with long-term lending. Over an extended period, the uncertainty regarding the borrower’s creditworthiness, inflation, and interest rate changes grows. Lenders need to compensate for this risk, which is why they usually set higher interest rates for loans with longer maturities compared to short-term loans.

In addition to risk, the time value of money plays a significant role. The longer the duration of the loan, the longer the lender’s capital is tied up, and the opportunity cost of investing that money elsewhere increases. Consequently, longer-term loans often come with a premium reflected in a higher interest rate.

This principle can be observed in the bond market as well, where longer-term bonds generally yield higher interest rates to attract investors willing to lock in their capital for an extended period as opposed to shorter-term securities, which carry less risk.