How Much Does an Irrevocable Letter of Credit Cost?
An irrevocable letter of credit (L/C) is typically used to ensure that payments to a seller are made on time and in the right amount. Commonly used in international commerce, irrevocable L/Cs are, as the name suggests, cannot be canceled. They work as a guarantee that a debtor’s payment to a creditor will be paid in a timely manner and in the full amount. L/Cs can be costly; thus, there needs to be full awareness of the method before entering into any deal.
How much does it cost?
- Letter of Credit Expediters in Portland, Oregon offers a flat negotiation/payment fee for an Export Letter of Credit at $150. In comparison, charges required by some commercial banks can be 1/10th or 1/8th percent. LCE provides a list of charges that commercial banks require from letter of credit transactions:
- negotiation/payment fee – $250
- discrepancy fee – $75
- reimbursement wire – $25
- courier expense – $65
- Fed wire payment – $25
- co-bank reimburse – $100
- According to CreditManagementWorld.com, the percentage cost for opening and paying a letter of credit in most developed countries will be .75% for L/Cs in excess of $100,000, although minimums vary from one bank to another. In underdeveloped nations, the issuing and negotiation cost can be more than 1.5%. The export letter of credit charges include the following: advising, payment, discrepancy, communication, courier and postage, reimbursement bank fees (which can range from $150 to $250), and bank-to-bank reimbursement services (which can range from $25 to $150).
- According to Warner Norcross & Judd LLP, a law office in Michigan, the premium for an L/C will consistently be smaller than the cost of an appeal bond and an LOC serving as collateral for the bond.
What is going to be included?
- A letter of credit basically pertains to a transaction between a buyer and a seller. In many cases, the letter is initiated by the buyer and directed to the seller or its beneficiary. An irrevocable letter of credit means that the letter of credit that is accepted by the seller cannot be modified or canceled without the authorization of the seller. Any change or modification necessitates consent from all parties involved.
- Required documents to apply for a letter of credit include the bill of lading, a commercial (or consular) invoice, the bill of exchange, the certificate of origin as well as documentation on insurance. Prices are stated in the currency of the letter of credit.
- The expiration date and place of the letter of credit is the last day of validity of the credit and the appointed place is that which the letter of credit specified for the presentation of documents and requirements for payment, negotiation or acceptance.
What are the extra costs?
- In a confirmed irrevocable letter of credit, a seller is assured of payment even if the buyer or the issuing bank defaults. In this case, the buyer pays an extra charge referred to as the confirmation fee, which can vary from bank to bank within a given country. This particular fee is added to the buyer’s account.
- The use of a letter of credit also entails bank charges, which will vary from one financial institution to another as well as on location.
Factors that influence the price:
- Fees. Banks normally charge a certain percentage for a letter of credit in addition to other charges previously mentioned. The fees are usually higher and are sometimes recommended for use in transactions of at least $30,000. Conversely, there are expediters that charge a flat fee for a letter of credit. They usually do not charge outside of advising fees and co-bank reimbursements.
- Letter of credit issuer. Commercial banks are not the only authorized entities that can issue letters of credit. There are also other financial companies that cater to this particular business. They typically specialize in the processing, negotiation, and obtaining of payments in a prompt manner. Due to this, they are usually able to charge a flat, fixed fee and have the ability to complete the processing of the documents for negotiation in a shorter time frame.
- Controllable charges. There are instances when sellers can control the cost of fees, particularly the advising fees and the discrepancy fees. This involves instructing the buyer to have the L/C advised straight to the bank they are already using. This method eliminates the need for advising charges. Additionally, discrepancy charges can be avoided by ensuring that clean, complete documents are presented. Avoiding these two charges can significantly decrease the overall cost of the financial procedure.
Tips to know:
- If the letter of credit does not mention whether it is revocable or irrevocable, it automatically means irrevocable.
- When establishing a letter of credit, the following elements must be addressed: beneficiary, amount, validity, seller’s bank, method of payment availability, necessary documents, notification address, description of goods, and confirmation order.
- The letter of credit is typically deemed to be automatically extended annually for periods of 1 year unless written notice is issued by the bank through registered or certified mail to the applicant at least 60 days before the then-current expiration date.
- The charges incurred from opening a letter of credit should be factored into the selling price. It is important for exporters to quote their export selling price with knowledge on all the costs involved (freight, insurance, bank export letter of credit charges, duty, as well as opening and payment fees incurred by the issuing bank.)
How can I save money?
- A letter of credit expediter may present economical options in the sense that they have lower fees compared with those required at most banks. Some L/C expediters offer programs to businesses needing over 50 L/C items every month.