Difference Between a Loan and a Letter of Credit

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A letter of credit is written to secure goods.
A letter of credit is written to secure goods. (Image: form -3 image by Rog999 from Fotolia.com)

Credit has long been the grease that lubricates the wheels of commerce. Two of the most common forms of credit, especially for small businesses, are loans and letters of credit.

Letter of Credit

A letter of credit is a letter from a third party, usually a bank or financial institution, promising to pay the seller for goods purchased by its customer. Mainly used in long distance and international transactions, letters of credit are usually sent to the seller once verification is received that the goods have been shipped.

Loan

A loan is money borrowed from a third party to purchase goods. The money is paid to the seller during the business transaction. The transaction is directly between the buyer and the seller.

Transaction Payment

Unlike a letter of credit, the seller receives immediate payment from a loan. A third party is not involved. Letters of credit were typically used before credit cards and traveler checks became everyday usage.

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