Letter of Credit vs Line of Credit - What's The Difference ?

Key Points:

• A letter of credit and a line of credit are both forms of funding or loans that sound similar but are very different in their execution.
• A letter of credit legally obligates a bank to pay a supplier and keep the supply going if the business owner can't pay the supplier at the time required.
• A line of credit is a loan where the business owner has funds always available to spend, at his discretion, on all his business needs that is automatically renewed (without any paperwork) when the funds are returned and interest paid.

What is a Letter of Credit?

A letter of credit is an agreement given by a business owner to a supplier promising that in case they can't pay a bank/lender or another 3rd party will. 

If the conditions outlined in the agreement are met, and the buyer does not make good on the payment, then the 3rd party is legally obligated to make the payment.

The letter of credit is designed to reduce the risk to the seller. There are various forms of letters of credit, some of which require more paperwork and documentation than others. For example, an irrevocable letter of credit requires all parties (including both banks) to agree to any changes in the documentation at all times.

Here are additional features of letters of credit:

• Letters of credit are commonly used in international trade 
• Businesses must meet requirements to get the funds outlined in a letter of credit.

What is a Line of Credit?

A business line of credit is a loan issued by a bank or another financial institution. Like a credit card, it provides you with a fixed sum of money that you can draw on when you require it and then pay back straight away or over a specific period.

Here are key features of a line of credit:

• You will be charged interest (The cost of the loan) once you borrow money
• The bank needs to approve all borrowers, where approval is based on the borrower’s connection with the bank and credit rating
• The interest rate is typically variable, so it is hard to know what you will eventually need to pay back 

There are two main options for a line of credit: secured and unsecured business line of credit. Secured requires collateral, while the unsecured option does not. To discover more about the difference between a secured and an unsecured line of credit read out article titled: Unsecured business line of credit: what it is and how it works. For an updated list of the most recommended lenders, visit our article about the best unsecured business line of credit companies.

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