Types of Letter of Credit (LC): How They Work, When to Use One, and Who Pays

A letter of credit (LC) is a bank’s promise to pay a seller when the seller presents the documents required by the LC and those documents comply with its terms. Common in international trade, an LC can reduce payment risk when buyers and sellers are new to each other, operate in different countries, or have concerns about banking or political risk.

This guide explains the main types of letter of credit, how an LC works, when to use one, and who usually pays the fees.

What are the main types of letter of credit?

“Types of LC” can refer to when payment is made, what protection the seller receives, or how the credit can be used.

By payment timing

Sight LC: The bank pays after checking that the seller’s documents comply with the LC.
Usance or deferred payment LC: The bank pays at a later agreed date, such as 30 or 90 days after shipment or document acceptance. This gives the buyer time to pay.
Acceptance LC: The bank accepts a time draft and pays it on its due date.

By the protection or flexibility offered

Confirmed LC: A second bank, often in the seller’s country, adds its own payment undertaking. Sellers may request confirmation if they are concerned about the issuing bank or country risk. Confirmation typically adds a fee.
Unconfirmed LC: The issuing bank provides the payment undertaking, while another bank may simply advise the seller that the LC was issued.
Transferable LC: The first beneficiary can transfer all or part of the credit to another beneficiary, if the LC expressly permits it. This can help an intermediary pay a supplier.
Back-to-back LC: A beneficiary uses an incoming LC as support to arrange a separate LC for a supplier. The two credits are separate and must be managed carefully.
Revolving LC: The credit renews for agreed amounts or periods, often for repeat shipments.
Standby LC (SBLC): Typically used as backup: the beneficiary can make a claim if the applicant fails to meet an obligation. It is different from a documentary LC used as the primary payment method.

The right structure depends on the deal. For a one-off shipment, a sight or deferred payment LC may be enough. A seller seeking protection against issuing-bank or country risk may ask for confirmation.

How does a letter of credit work?

A typical documentary LC works like this:

Buyer and seller agree on the terms. They decide whether payment will be by LC, which documents are required, when shipment must happen, and when the credit expires.
The buyer applies to a bank. The buyer’s bank reviews the application and issues the LC in favor of the seller. The buyer is the applicant; the seller is the beneficiary.
The seller checks the LC. Before shipping, the seller should confirm that the terms are workable and match the sales agreement.
The seller ships the goods and presents documents. These may include a commercial invoice, transport document, packing list, or insurance document, depending on the LC.
The bank examines the documents. Banks assess the presentation against the LC’s requirements. If the documents comply, the bank pays at sight or according to the agreed deferred terms.
The buyer pays or reimburses the issuing bank. The buyer then uses the documents to take delivery or claim the goods, as applicable.

An LC is document-based: banks examine the documents, not the goods themselves. A bank’s payment undertaking depends on a complying presentation, so unclear or overly detailed document requirements can create delays or disputes. The ICC’s UCP 600 rules apply when the credit says it is subject to them; they include standards for examining documents. (International Chamber of Commerce UCP 600)

When should you use an LC as a payment term?

An LC can make sense when:

The buyer and seller have limited trading history.
The seller is concerned about the buyer’s ability or willingness to pay.
The buyer wants payment to depend on presentation of agreed shipping documents.
The transaction involves cross-border, banking, or country risk.
The parties need a defined payment process for a high-value shipment.

L/C involves bank fees and document work, so they may not be the most practical choice for every order. Letter of Credit (LC) is described as a payment term especially useful in higher-risk situations or with new or less-established trading relationships, where the exporter is comfortable with the importer’s bank.

Who pays for a letter of credit: buyer or seller?

Usually, the buyer pays the issuing bank’s fee because the buyer applies for the LC. The seller may pay charges for services it requests or receives, such as advising, confirmation, or negotiation. The sales contract and LC can allocate charges differently, and bank practices vary by country and transaction.

Before agreeing, both parties should confirm which fees apply, who bears them, and whether charges from banks in either country are included. For example, a seller that requests confirmation may need to pay the confirming bank’s fee unless the parties agree otherwise.

Conclusion

A letter of credit can provide a structured way to manage payment risk in international trade. The buyer’s bank promises to pay when the seller presents documents that comply with the LC, and the buyer usually pays the issuance fee. The best type—sight, deferred, confirmed, transferable, or another structure—depends on the payment schedule, risk, and needs of the transaction. Agree on the documents, deadlines, and bank charges before the LC is issued.

FAQs

Is a letter of credit a guarantee of payment?

It is a bank undertaking to pay against a complying presentation under the LC’s terms. Payment is not automatic if required documents are missing or fail to comply.

2. Does an LC guarantee the quality of the goods?

No. Banks examine documents, not the goods’ actual quality or condition. Buyers should use appropriate inspection or quality-control arrangements where needed.

3. Can the seller ask for a confirmed LC?

Yes. The buyer must arrange for a second bank to add confirmation, usually through the issuing bank. The seller should agree who pays the confirmation fee.

4. Is a letter of credit suitable for domestic trade?

It can be used domestically, but it is most commonly associated with international trade. Whether it is worthwhile depends on the transaction’s value, risk, and costs.