Why is a letter of credit important?

Guidelines for letters of credit are set up in Article 5 of the Uniform Commercial Code. Letters of credit are important for business entities and individuals alike. When a business is attempting to purchase goods, services and technology to serve their clients, a letter of credit is essential. Most businesses do not pay cash or write a check for large purchases. When contacting new vendors, the letter of credit allows the vendor to see that the business is credit worthy and pays their bills in a timely manner. The vendor can then take on very little risk in forwarding the goods or services to the business organization without obtaining payment up front.

The letter of credit also, at times, guarantees the seller that the money will be received even if the purchasing business defaults – a guarantee of funds. The same goes for a person who wishes to know how much of a mortgage they can afford before searching for a new home. The bank reviews the potential buyer’s financial situation and issues a letter of credit to a potential seller or real estate agent that the buyer is indeed credit worthy and not wasting everyone’s time touring homes, requesting information and asking questions. In this manner, the seller and agent are assured that should the buyer be truly interested in making a purchase, the bank will back them up with a mortgage and help them obtain the necessary funds.

LawGuru Staff

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