What Is a Letter of Credit? A Plain-English Guide for U.S. Importers and Exporters

If you're a U.S. importer or exporter doing business internationally, you've probably heard the term Letter of Credit — or LC. It's one of the most widely used instruments in global trade finance, and for good reason: it solves one of the most fundamental problems in cross-border commerce.

That problem? Trust.

When a buyer in the United States agrees to purchase goods from a supplier in another country, both parties face real risk. The buyer doesn't want to pay before the goods arrive. The seller doesn't want to ship before they're paid. A Letter of Credit is the mechanism that resolves this standoff — using the banking system as a trusted intermediary.

This guide explains what a Letter of Credit is, how it works step by step, and when it makes sense for your business.

In domestic transactions, buyers and sellers often have established relationships, shared legal jurisdiction, and credit history to fall back on. In international trade, those safety nets largely disappear.

Consider a U.S. importer purchasing $500,000 worth of manufactured goods from a supplier in Southeast Asia. The importer wants to inspect the goods before paying. The supplier wants payment before shipping. Neither party knows the other well enough to simply trust.

A Letter of Credit removes the need for that trust by replacing it with a bank guarantee. The importer's bank commits to paying the supplier — but only when the supplier provides specific documents proving the goods were shipped as agreed.

A Letter of Credit (LC) is a written commitment issued by a bank (the issuing bank) on behalf of a buyer (the applicant), guaranteeing payment to a seller (the beneficiary) provided the seller presents documents that comply with the terms specified in the LC.

In plain terms: the bank promises to pay the seller if the seller can prove they did what they said they would do.

The documents typically required include:

• Bill of Lading — proof that goods were shipped
• Commercial Invoice — itemized description of the goods and their value
• Packing List — detailed breakdown of the shipment contents
• Certificate of Origin — confirms where the goods were manufactured
• Insurance Certificate — proof the shipment is insured
• Inspection Certificate — third-party verification of goods quality (when required)

The exact documents required are specified in the LC itself and agreed upon by both parties before the LC is issued.

Here is the typical flow of a Letter of Credit transaction:

The importer and exporter negotiate the sale — price, quantity, delivery terms, and the requirement that payment will be made via Letter of Credit.

The importer (buyer) applies to their bank — the issuing bank — to open a Letter of Credit in favor of the exporter. The application specifies all the required documents, the expiry date, and the amount.

The issuing bank reviews the application, approves it (based on the importer's creditworthiness), and issues the LC. The LC is transmitted to the exporter's bank — the advising bank or confirming bank — in the exporter's country.

Once the exporter receives and reviews the LC, they ship the goods and gather all the required documents.

The exporter submits the required documents to their bank (the advising or confirming bank) within the timeframe specified in the LC.

The advising bank reviews the documents for compliance and forwards them to the issuing bank. If the documents comply with the LC terms, the issuing bank releases payment to the exporter's bank, which credits the exporter.

The issuing bank releases the shipping documents to the importer, who uses them to take possession of the goods.

Not all LCs are the same. Here are the most common types U.S. businesses encounter:

The standard LC used in most import/export transactions. Payment is made upon presentation of compliant shipping documents.

Functions more like a bank guarantee than a payment mechanism. The beneficiary only draws on it if the applicant fails to fulfill their contractual obligations. Commonly used in service contracts and project finance.

In addition to the issuing bank's commitment, a second bank (usually in the exporter's country) adds its own guarantee of payment. This provides the exporter with additional security, particularly when the issuing bank is in a country with higher political or financial risk.

Automatically renews for a set amount over a defined period. Useful for ongoing supplier relationships with regular shipment schedules.

Allows the beneficiary (exporter) to transfer part or all of the LC to a third party — typically a supplier or subcontractor. Common in trading company transactions.

For U.S. importers, an LC provides several important protections:

Payment is conditional. Your bank only pays the supplier when they present documents proving the goods were shipped as specified. If the documents don't match the LC terms, payment is withheld.

Dispute leverage. If goods arrive damaged or not as described, the documentary requirement creates a paper trail that supports your position.

Supplier confidence. Many overseas suppliers — particularly in Asia, Latin America, and the Middle East — require an LC before they will commit to producing or shipping goods. Having LC capability opens doors to suppliers who won't extend open account terms to new buyers.

For U.S. exporters, an LC provides payment certainty that open account terms cannot:

Bank-backed payment guarantee. Instead of relying on the buyer's promise to pay, you have a commitment from a financial institution. This is especially valuable when selling to buyers in markets where enforcing contracts is difficult.

Financing against the LC. Many banks will advance funds against a confirmed LC before the goods even ship — improving your cash flow and allowing you to fulfill larger orders.

Access to new markets. Buyers in many countries expect LC payment terms. Offering this option makes your business competitive in markets where open account terms are uncommon.

LCs are powerful — but they require precision. The most common issue is documentary discrepancy: when the documents presented by the exporter don't exactly match the terms specified in the LC.

Even minor discrepancies — a misspelled company name, a date that falls outside the allowed window, a missing endorsement — can delay or block payment. This is why working with experienced trade finance professionals and banks is important.

Other challenges include:

• Cost: LC fees (issuance, advising, confirmation, amendment) add to transaction costs
• Complexity: Preparing compliant documents requires attention to detail and familiarity with international trade documentation
• Time: The documentary process adds time compared to open account transactions

For most businesses, these challenges are manageable — especially when weighed against the risk of non-payment or non-delivery in a cross-border transaction.

An LC is typically the right choice when:

• You're working with a new supplier or buyer you haven't transacted with before
• The transaction value is significant enough to justify the cost and complexity
• You're buying from or selling to a market where payment risk or delivery risk is elevated
• Your counterparty requires it as a condition of the transaction

For established relationships with trusted counterparties, simpler payment methods (open account, documentary collections) may be more efficient.

Navigating the Letter of Credit process — from application to document presentation — requires the right banking relationships and a clear understanding of the requirements. At Sellathon Consulting, we help U.S. importers and exporters understand their trade finance options and connect with established financial institutions that offer LC facilities suited to their transaction profile.

Submit a trade finance inquiry →

Or contact our team to discuss your specific situation.

Sellathon Consulting is a Houston-based trade finance consulting firm helping U.S. importers and exporters access the right financial solutions through established institutions. Learn more about us →

Related reading:

• How Import Finance Works for U.S. Businesses
• Export Finance: A Guide for U.S. Exporters
• Trade Finance vs. Traditional Business Loans: What's the Difference?