Final answer:
Lenders charge higher interest rates on longer fixed-term loans to compensate for the increased risk and potential loss of value due to inflation over time. For longer terms, the fixed interest rate may become lower than future market rates, and lenders need to accommodate this in their initial rate offerings.
Step-by-step explanation:
Lenders generally charge a higher interest rate on longer fixed-term periods for fixed-rate loans. The primary reason for this is the increased risk to the lender associated with long-term lending. Over an extended period, there are more uncertainties, such as changes in the economy, inflation rates, and the borrower's financial situation. Additionally, there is a higher chance that inflation can erode the value of the returned funds over time.
With a fixed-rate loan, the lender is taking on the risk that the interest rate it charges over the course of the loan may end up being lower than future market rates, mainly due to inflation. Therefore, for longer terms, lenders need to compensate for this increased risk and potential loss of value by charging a higher interest rate.
Comparatively, with adjustable-rate mortgages (ARMs), the interest rate can fluctuate with market rates or inflation, allowing lenders to adjust the rate to match current conditions. This is why ARMs often start with lower interest rates than fixed-rate loans, as they offer lenders some protection against inflation and changes in the market.