Sometimes, sellers require a form of guarantee that a buyer will keep to the terms of the agreement and payback. This emphasizes the need for a letter of credit (LOC). A letter of credit serves its purpose by acting as a substitute for credit taken from any financial institution for a particular client. In turn, they facilitate trade. A letter of credit is an essential financial tool in business transactions. Both the national and international markets use the letter of credit to facilitate payments and transactions. A bank or any financial institution acts as a third party between the buyer and the seller and ensures the payment of the funds by completing certain obligations.
What makes a letter of credit useful?
Letters of credit are useful tools that are intended to help you improve your credit score by eliminating the bad elements of your credit reports. These letters are typically sent to creditors and collection agencies as an instrument to protect you from fraud and at the same time to judge the credibility of the creditor concerning their rights to associate with your credit report. The letters of credit are of different types depending on their uses. A letter of credit is related in some way or another with the removal of the incorrect negative listings from your credit report, thus improving your credit score. Here are some types of letter of credit:
Types of Letter of Credit
Revolving
For a customer to be able to make any amount of draws that do not exceed a certain limit for a specific period, what is required is a Revolving letter of credit.
Commercial
This Letter of Credit employs a more direct payment method. Here, the issuing bank makes payments to the beneficiary. Directly corresponding to this is the Standby letter of credit.
Standby
This is a letter of credit that ensures payment if the buyer does not pay, after complying with all Standby Letter of Credit terms, if the seller proves that the promised payment was not made. In this situation, the bank will pay the seller. Simply put, it does not facilitate a transaction but guarantees payment.
Traveller’s Letter of Credit
For those traveling abroad, this letter of credit will guarantee that the drafts made in certain foreign banks are honored by the issuing banks.
Confirmed
For a confirmed letter of credit, another bank called the issuing bank is involved to guarantee the letter of credit. This second bank, which is usually the seller’s bank acts as the confirming bank. If the issuing bank and holder don’t comply, the confirming bank then guarantees payment. Typically, this request is made by the issuing bank in international transactions.
Unconfirmed
This is the most common letter of credit. It is only insured by the issuing bank, and no second bank is needed as a guarantee.
Letter of credit can help in improving your credit score. The information provided here is an excellent insight into what you need to know about a letter of credit.