With a letter of credit, a bank or lender guarantees that it will pay you, the seller the amount of money due from your customer, the purchaser. For this to happen, as the supplier, you must show proof that you delivered the goods properly. The buyer is usually the bank’s client and possesses the letter of credit. Conversely, as a line of credit debtor, you can borrow money from a bank up to what ever limit your bank sets. You don’t need to draw the entire amount at once; you can choose to make use of only part of the credit line to suit your needs.
The purpose of letters of credit is to facilitate transactions. Suppliers are sure that they will get paid and buyers are sure that they will receive the goods. Without it, a supplier might not be willing to ship goods first, for fear that the buyer will not pay. The buyer might also not be willing to pay the seller first, for fear that the seller will take the payment and run. On the other hand, the purpose of a line of credit is to allow you to purchase, invest or otherwise spend now, without having to pay for your purchases immediately.
International trade makes wide use of letters of credit because uncertainty is often greater at the global level. Parties to a transaction are in different countries, and goods have to cross oceans to arrive at their destination. A ship and the goods that it is carrying could be delayed for any number of reasons, including piracy and turmoil within the exporting country. Conversely, bank customers use lines of credit to increase their purchasing power. For example, you can purchase a forklift and begin renovations on your premises without tapping into your cash accounts.
The two are different when it comes to interest rates. A customer doesn’t pay interest for a letter of credit. Instead, the bank charges fees and commissions for playing the part of an intermediary. When you open a line of credit, you'll typically pay opening and annual fees. You'll also pay interest, but only on the portion of the money you withdraw, not the full amount that you can borrow. This means that if you have a $50,000 credit line and withdraw only half of this amount, you'll only pay interest on $25,000.