What is a ‘Line Of Credit – LOC’
A line of credit, abbreviated as LOC, is an arrangement between a financial institution, usually a bank, and a customer that establishes a maximum loan balance that the lender permits the borrower to access or maintain. The borrower can access funds from the line of credit at any time, as long as he does not exceed the maximum amount set in the agreement and as long as he meets any other requirements set by the financial institution, such as making timely minimum payments.
BREAKING DOWN ‘Line Of Credit – LOC’
The main advantage of a line of credit is its built-in flexibility. Borrowers can request a certain amount, but they do not have to use it all. Rather, borrowers can tailor what they spend to their needs, and they only have to pay interest on the amount they spend, not on the entire credit line. In addition, consumers can also adjust their repayment amounts as needed, based on their budget or cash flow. For example, borrowers can repay the entire outstanding balance at once, or they can opt to just make the minimum monthly payments.
A line of credit is a type of revolving account. This means that the borrower can spend the money, repay it and spend it again, in a virtually never-ending, revolving cycle. Revolving accounts such as lines of credit and credit cards exist in contrast to installment loans such as mortgages, car loans and signature loans. With installment loans, consumers borrow a set amount of money, and they repay it in equal monthly installments until the loan is paid off. Once an installment loan has been paid off, the consumer cannot spend the funds again unless he applies for a new loan.
Unsecured LOCs Versus Secured LOCs
In most cases, lines of credit are unsecured loans. This means that there is no collateral backing them. However, there is one notable exception, which is a home equity lines of credit (HELOC). This line of credit is secured by the equity in the borrower’s home, but it works exactly like any other line of credit.
Demand Line of Credit
A demand LOC is a rare type of credit line in which the lender can call the loan due at any time. As with a standard LOC, the lender sets a maximum amount the borrower can spend, and the borrower can spend any amount up to the limit. With demand loans, the borrower may make small monthly payments, or he or she may simply wait until the lender demands repayment.
What is a ‘Letter Of Credit’
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 payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. Due to the nature of international dealings, including factors such as distance, differing laws in each country, and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade.
BREAKING DOWN ‘Letter Of Credit’
Because a letter of credit is typically a negotiable instrument, the issuing bank pays the beneficiary or any bank nominated by the beneficiary. If a letter of credit is transferrable, the beneficiary may assign another entity, such as a corporate parent or a third party, the right to draw.
Funding a Letter of Credit
Banks typically require a pledge of securities or cash as collateral for issuing a letter of credit. Banks also collect a fee for service, typically a percentage of the size of the letter of credit. The International Chamber of Commerce Uniform Customs and Practice for Documentary Credits oversees letters of credit used in international transactions.
Example of a Letter of Credit
Citibank offers letters of credit for buyers in Latin America, Africa, Eastern Europe, Asia and the Middle East who may have difficulty obtaining international credit on their own. Citibank’s letters of credit help exporters minimize the importer’s country risk and the issuing bank’s commercial credit risk. Citibank can provide letters of credit typically within two business days, guaranteeing payment by the confirming Citibank branch. This benefit is especially valuable when a client is located in a potentially unstable economic environment.
Types of Letters of Credit
A commercial letter of credit is a direct payment method in which the issuing bank makes the payments to the beneficiary. In contrast, a standby letter of credit is a secondary payment method in which the bank pays the beneficiary only when the holder cannot.
A revolving letter of credit lets the customer make any number of draws within a certain limit during a specific time period. A traveler’s letter of credit guarantees the issuing banks will honor drafts made at certain foreign banks.
A confirmed letter of credit involves a bank other than the issuing bank guaranteeing the letter of credit. The second bank is the confirming bank, typically the seller’s bank. The confirming bank ensures payment under the letter of credit if the holder and the issuing bank default. The issuing bank in international transactions typically requests this arrangement.