Difference Between Letter of Credit and Line of Credit

Money is the medium of exchange in the form of coins or banknotes. It is indeed used to make the payment for goods and services, and also to buy things and pay debts and so on.

Among buyers, sellers, loan borrowers, and the financial institution or bank, Letter of Credit and Line of Credit play their respective important roles.

Letter of Credit vs Line of Credit

The main difference between the letter of credit and line of credit is that a Letter of credit is a document issued by the bank to the seller on request of the buyer. Whereas the line of credit is a financial instrument that helps the customer to borrow a maximum amount from the bank.

Letter of credit vs Line of credit

Letter of credit is a financial document that bank or financial institution issues to the sellers on request of the buyers. Compare to the line of credit its a very different instrument.

Line of credit is an instrument between the financial institution and the borrower, it fixes the maximum amount a person can borrow at any time.


 

Comparison Table Between Letter of Credit and Line of Credit (in Tabular Form)

Parameter of ComparisonLetter of CreditLine of Credit
UsageA letter of credit ensures that the payment is done promptly to the seller from the buyer’s end.Line of credit is the financial instrument that supports the business or an individual with financial loans.
FlexibilityIt’s rigid, it can be used only once to make payment to the seller from buyerIt is flexible, the fixed amount can be used by the customer to borrow any time
Fees and RatedThere is a fixed fee by bank for a letter of credit and there is no need of paying any kind of interestLine of credit fee is fixed along with fees borrower has to pay interest only for borrowed funds.
Parties involvedIn the entire context of the letter of credit, 4 entities are involved; buyer and seller and their respective 2 banksThere are only two parties are involved in the process, borrower or customer and financial institution or bank
GeographyLetter of credit mainly used in international trade or globally where buyer and sellers are from different countriesCompare to the letter of credit, line of credit is used locally where customer and bank resides.

 

What is Letter of Credit?

A letter of credit is a financial document or an instrument that the financial institution or the bank issues to the sellers on the request of the buyer.

A letter of credit is used to avoid credit risk. The purposes of the letter of credit are, where the supplier has an assurance that the buyer will make payment after shipping the goods.

There are several types of letters of credit available for international trade. They are:

  1. A commercial letter of credit
  2. Revolving letter of credit
  3. Traveller’s letter of credit
  4. Confirmed letter of credit

Letter of credit normally provided within two business days. Guaranteeing the payment from the buyer end if it fails then from the bank.

letter of credit
 

What is Line of Credit?

Line of credit is an instrument between the financial institution and the customer or borrower, the maximum loan can the customer borrow by using the line of credit at any time up to fixed amount decided by the financial institution for business or day to day life activity.

In the line of credit, only two parties will be involved customer and financial institutions. There are two types of lines of credit, they are secured line of credit and unsecured line of credit.

Most of the lines of credits are unsecured. Where the borrower borrows the loan from the financial institution without promising any collateral.

Line of credit is considered as the revolving account where the financial institution allows the borrower to spend money repay with interest and again spend, it is a never-ending cycle where revolving.

Line of credit has different types of forms where each follows under the secured or unsecured line of credit. They are

  1. A personal line of credit
  2. Home equity line of credit
  3. Demand line of credit
  4. Securities – a backed line of credit
  5. A business line of credit
line of credit

Main Differences Between Letter of Credit and Line of Credit

  1. The main difference between the letter of credit and line of credit is a Letter of credit is a document issued by the bank to the seller and it is issued upon the buyer’s request.
  2. Letter of credit used to make payment to the seller by the buyer in an international trade transaction. Whereas the line of credit used by the customer to borrow loans from bank to business or personal reason.

 

Conclusion

Letter of credit and Line of credit sounds similar when hearing about this but both have different meanings and functions. Letter of credit mainly used globally for international trade among buyers and sellers to make payment.

Line of credit is an instrument; financial institution provides to its customer. The main advantage of the line of credit is the borrower can borrow money from a financial institution only how much he needed.

Both letters of credit and line of credit have it is own advantages and disadvantages, before using any services contacting financial institutions is good.


References

  1. https://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=4155&context=lcp
  2. https://www.jstor.org/stable/838450
  3. https://repository.law.umich.edu/cgi/viewcontent.cgi?article=2776&context=mlr
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