How Much Does a Letter of Credit Cost?
Letters of credit are used in many international businesses. A letter of credit is a type of document used to secure payment from buyers. It is a method used to guarantee that the seller will get paid and that the buyer gets a shipment. Letters of credit are suitable for those who take part in export transactions and want to reduce the risks that likely occur in international trade.
How much does it cost?
- On average, a letter of credit can range anywhere from 2% to 8% of the total value. So if the value was $100,000, it’s best to budget about $8,000.
- According to International Trade Finance, there are no upfront costs for clients who obtain a letter of credit. All fees are collected by International Trade Finance from the invoice payments from the buyer at the close of each transaction. The company charges a minimum flat fee of $500 for each transaction. At an 8% rate, the L/C would require at least $6,250 to meet the aforementioned minimum. Additionally, the company advises its clients use letters of credit for shipments that amount to more than $10,000 in order for the L/C service to be beneficial.
What is going to be included?
- The letter of credit is of two types: revocable and irrevocable. A revocable L/C can be revoked without the consent of the seller and can be changed up to the time the documents are presented. An irrevocable L/C cannot be canceled or modified without the permission of everyone involved parties, including the seller. Unless stated otherwise, all letters of credit are irrevocable.
- In transactions involving a letter of credit, also referred to as a documentary credit, the buyer’s bank agrees to pay the seller once the terms and conditions of the L/C have been met and accomplished.
- Banks are required to check the documents and make the payment in accordance with the documents that are compliant with the terms stated in the L/C. Letters of credit are subject to international rules, or the Uniform Customs and Practice for Documentary Credits; these are published by the International Chamber of Commerce.
What are the extra costs?
- The seller typically shoulders the bank charges and costs for the necessary documentation and paperwork required in the letter of credit.
- In many instances, sellers need to have a credit facility with the issuing bank before the L/C will be issued.
- The bank often charges an annual fee as reserve in case the borrower is unable to make payments.
Factors that influence the price:
- Letter of credit issuer. Letters of credit can be issued by a bank or any financial institution. While a letter of credit is typically expensive, some issuers, such as letter of credit expediters, offer the service for a flat fee much lower than in banks. They specialize in the processing, negotiating and acquiring of payments quickly under L/Cs or documentary collections. For this reason, they are able to charge a fixed fee.
- Fees. Applying for a letter of credit entails a number of fees. These include the following fees: advising, payment, discrepancy, communication, courier and postage, and reimbursement charges. The rates vary from bank to bank. It is important for the seller to be aware of the full amount of the possible charges and add the costs to the purchase price to protect themselves against likely loss.
- Controllable charges. Preparing a letter of credit involves a range of fees that need to be paid. However, there are two kinds of charges that can be avoided, which then results to lower overall cost. One is the advising fee, which refers to the charges incurred for bank advice. To circumvent this particular cost, the buyer will need to have the letter of credit addressed to a bank he currently uses. Discrepancy fees are another cost that can be prevented. The key is to ensure that all documents are completed and presented properly.
Tips to know:
- The seller is guaranteed the payment by the issuing bank as long as he is able to present all the necessary documents that fulfill the terms detailed in the letter of credit.
- The buyer can postpone the payment and at the same time guarantee the payment to the seller, which is referred to as a letter of credit with deferred payment.
- Withdrawal of cancellation of a letter of credit can only be done by the consent of the receiving party, or the seller.
- Oftentimes, the buyer needs to have a line of credit with a bank before the bank is able to issue a letter of credit. The amount under each L/C issued is applied against the said line of credit beginning from the issuance date until the last payment.
How can I save money?
- If you are planning to apply for a good number of letters of credit, inquire about getting volume discounts. Discounted rates are typically offered by financial companies that specialize in the preparation of export documentation and letters of credit. Make sure to perform due diligence, make a list of prospects and compare their rates as well as the accompanying services prior to deciding on what company to select.