A letter of credit is a letter from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.
A letter of credit functions similarly to an escrow account, where a third party coordinates holds onto the money needed to complete a transaction on behalf of the other two parties in a deal. This letter certifies that the buyer has good credit (hence the name), and can afford to pay for what it has purchased. The bank will release funds at a point in the transaction that you and your customer have agreed to.
Key Features of a Letter of Credit
- Transfer and Assignment
- Sight and Time Draft