Bank Credit Definition | What Is Bank Credit

1. What is Bank Credit?

Bank credit is a form of financing in which a bank allows the borrower to use the funds from it for any purpose, most often at a predetermined interest rate. A bank credit may be used by the borrower to purchase an asset with a term longer than one year.

For example, Bob wants to buy a new car and decides to take out a bank loan. He applies to CarCo and, after determining his creditworthiness, the company offers him credit for $15,000 at 1% interest per month (12% annual rate) that he can use to buy the car.

When the term of the contract expires, Bob will repay $16,146 to CarCo.

The amount by which the bank credit exceeds the value of the asset acquired is what is called interest, while the penalty for not returning it on time or in full is called a fine.

2. What are the advantages of bank credit?

One advantage of taking out a bank loan to buy an asset with more than one year of duration is that you will have the opportunity to get more value from it. In fact, if Bob had taken out a personal credit for the same amount at 12% annual interest, he would only get $12,000 in his pocket when it expires.

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Another advantage of a bank loan is that it gives individuals greater flexibility because they can use the credit for any purpose.

3. What are the disadvantages of bank credit?

One of the disadvantages of taking out a bank loan to buy an asset with more than one year of duration is that it does not yield guaranteed results, as is the case with other types of investments. Thus, Bob may have planned to use his $15,000 bank credit to buy a new car and pay for it using the savings he had until then.

But if after buying the car he realizes that its value has dropped by 15%, his spending power will have fallen as well. In this way, Bob does not only lose the funds he planned to use for purchasing the car but also those that he had been saving until then.

In addition, when the term of credit expires, you will have to return the total amount agreed on it. Thus, if Bob spends more than expected with his bank credit for a new car, he may not have enough money in the future to repay it or cover other basic needs.

4. How do I get a bank credit?

To get bank credit, individuals must go to the main branch of their bank. The documents required will vary depending on whether or not CarCo has given you the green light to take out the credit. Usually, among them are legal documents (such as your RUT card) and evidence that shows you have an income (e.g., a salary certificate or guarantee letter from your employer).

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5. Types of bank credits

There are several types of bank credits. The most common ones include:

  • Personal credit, which is aimed at individuals or companies;
  • Mortgage credit, which is intended to finance the purchase of a house; and
  • Loans for consumption (cars, computers…), are designed to cover the costs stemming from the purchase of consumer goods, such as furniture or a TV.

6. What types of bank credits do not exist?

Some credit forms that existed years ago have been discontinued: for example:

  • The car loan has fallen out of favor because it is hard to recover and results in high costs; and
  • Credits to buy term life insurance, which made it possible to receive funds in the form of a life insurance policy.