What Is a Letter of Credit and Do You Need One?

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Letter of Credit Defined
How a Letter of Credit Works
Letter of Credit Example
The buyer and seller draw up a sales agreement, and the seller applies for a letter of credit. The buyer’s bank writes a letter of credit and sends it to the seller’s bank for approval. Once approved, the seller's bank sends it to the seller. The seller ships the goods the buyer ordered. The seller sends documentation of the shipment to their own bank, which verifies the documents. If they are correct, the seller's bank submits the documents to the buyer’s bank. The buyer’s bank sends payment to the seller’s bank, and the buyer can claim their goods.
How Much Does a Bank Letter of Credit Cost?
Are There Different Types of Letters of Credit?
Commercial Letter of Credit
Standby Letter of Credit
Revolving Letter of Credit
Traveler’s Letter of Credit
Confirmed Letter of Credit
What Are the Advantages of a Letter of Credit?
Reduces Risk
Outline Terms of the Deal
Provide Security for Buyer and Seller
What Are the Disadvantages of a Letter of Credit?
Banks Charge a Fee
Increased Transaction Times
Banks May Require Collateral
When You Should Use a Letter of Credit
The Takeaway
Frequently Asked Questions
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About the Author
Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.
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