Letter of Credit for Imports: How It Works, Costs, and When You Need One

You find a new supplier in Shenzhen. They want $80,000 for a full container of electronics. They won't ship with just a 30% deposit — they don't know you. You won't wire $80,000 to a company you've never worked with — you don't know them. Deadlock. The solution: a Letter of Credit. Your bank guarantees payment to their bank IF (and only if) the supplier proves they shipped the goods correctly. The supplier gets bank-guaranteed payment security. You get proof of shipment before your money is released. Both parties are protected by banks. That's the LC in a nutshell.

How a Letter of Credit works: step by step

The complete LC timeline

1. Buyer and seller agree on terms: Product specs, price, delivery date, Incoterm, documents required
2. Buyer applies to their bank: Submits LC application specifying all terms and document requirements. Bank evaluates buyer's creditworthiness.
3. Issuing bank issues the LC: Buyer's bank (issuing bank) creates the LC and sends it via SWIFT to the seller's bank (advising bank)
4. Advising bank notifies seller: Seller receives the LC and reviews all terms. If satisfied, production begins.
5. Seller ships goods: Once goods are ready and shipped, seller collects all required documents (B/L, invoice, packing list, certificates)
6. Seller presents documents to their bank: Within the presentation period (usually 21 days after shipment or before LC expiry, whichever is earlier)
7. Bank examines documents: The advising/nominated bank checks every document against LC requirements. Banks have 5 banking days to examine.
8. If compliant → payment: Documents are sent to issuing bank, which reimburses the advising bank and releases documents to the buyer
9. Buyer receives documents: Takes the B/L and other documents to the shipping line/customs broker to collect cargo
10. Buyer reimburses their bank: Pays the issuing bank per their credit arrangement (immediately or at maturity for usance/deferred LCs)

Types of Letters of Credit

By payment timing

By security level

By flexibility

• Transferable LC: Seller can transfer part/all of the LC to a third party (e.g., their supplier) — used by trading companies
• Back-to-Back LC: Seller uses the received LC as security to open a new LC to their own supplier — enables intermediary trade
• Revolving LC: Automatically renews for a specified period/amount — good for regular repeat shipments

Cost breakdown: what you'll pay

For a $100,000 Sight LC from China to the US:

Total transaction cost: roughly 1-2% of LC value. This is the "price of trust" — what you pay to eliminate payment and shipment risk when dealing with unknown parties.

LC vs. T/T wire transfer: comparison

The typical progression

Most importer-supplier relationships follow this path:

1. First order: LC (neither party trusts the other)
2. 2nd-3rd orders: 30% T/T deposit + 70% T/T before shipment (building trust)
3. 4th+ orders: 30% deposit + 70% against B/L copy (or net 30 after delivery for trusted partners)

Suppliers often offer 2-5% price discounts for T/T vs. LC because LCs are expensive and administratively painful for them too.

Documents that must be perfect

Banks examine documents with extreme strictness. Under UCP 600 (the international rules governing LCs), documents must comply "on their face" — meaning exact compliance with LC terms. Common rejection causes:

Commercial Invoice requirements

• Description of goods must match LC wording exactly (not "similar" or "equivalent")
• Amount must not exceed LC value
• Must be addressed to the applicant (buyer) as named in the LC
• Must be issued by the beneficiary (seller) named in the LC
• Currency must match LC currency

Bill of Lading requirements

• Must be "shipped on board" (not just "received for shipment")
• On-board date must be within the LC's latest shipment date
• Must be "clean" — no clauses noting damage
• Consignee must be as per LC (usually "to order of [issuing bank]")
• Port of loading and discharge must match LC exactly
• Full set of originals presented (if LC says 3/3, all 3 must be there)

Insurance document requirements (for CIF/CIP terms)

• Coverage amount must be at least 110% of CIF value (or as LC specifies)
• Must cover the same voyage as the B/L
• Must be issued before or on the shipment date (not after)
• Risks covered must be as specified in the LC
• Must be in the same currency as the LC

LC process: timeline example

Real-world timeline for a $50,000 LC from a US buyer to a Chinese seller:

Total process: roughly 50 days from LC issuance to cargo release. Compare to T/T where the supplier ships as soon as they have your 30% deposit and the goods are ready.

Common LC mistakes importers make

Mistake 1: Making the LC too restrictive

Every specific requirement in the LC is a potential point of failure. If you specify "loading port: Shenzhen" and the supplier ships from nearby Guangzhou port instead, the documents are discrepant — even if Guangzhou is perfectly acceptable to you. Keep terms as broad as possible while still protecting your interests.

Mistake 2: Not including inspection requirements

Remember: banks don't inspect goods. If you want assurance that the goods are actually what you ordered, require an independent inspection certificate (e.g., "SGS pre-shipment inspection certificate confirming goods conform to Purchase Order #XXX specifications"). Without this, the supplier can ship garbage with perfect documents and get paid.

Mistake 3: Insufficient time allowances

Build buffer into LC dates:

• Latest shipment date: add 2 weeks beyond expected production completion
• Document presentation period: allow 21 days (the UCP 600 default)
• LC expiry date: at least 7-10 days after latest presentation date

Amendments to extend dates cost $50-$100 each and require all parties' agreement. Better to build in buffer from the start.

Mistake 4: Not getting the seller's acceptance before finalizing

Share the draft LC with your seller BEFORE issuing it. Let them review every term and confirm they can comply with all document requirements. It's much cheaper to adjust before issuance than to amend after.

Mistake 5: Ignoring the UCP 600 rules

All LCs are governed by UCP 600 (Uniform Customs and Practice for Documentary Credits) published by the International Chamber of Commerce. Understanding the basics saves disputes:

• Documents must be presented within 21 days of shipment (unless LC specifies otherwise)
• Banks have 5 banking days to examine documents
• Banks only check what's stated in the LC — not implied
• Partial shipments are allowed unless prohibited in the LC

When NOT to use a Letter of Credit

• Orders under $20,000: Bank fees (1-2%) eat into margins disproportionately for small orders. Use T/T with trade assurance or PayPal instead.
• Established supplier relationship: If you've done 5+ successful orders with a supplier, LC is expensive overkill. Move to T/T.
• Urgent orders: LC setup and document processing add 1-2 weeks. If speed matters, T/T is faster.
• Domestic transactions: LCs are for international trade. Domestically, use purchase orders and standard payment terms.
• Commodity purchases with price volatility: If market price might drop during production, the buyer might regret the LC commitment. Flexible T/T terms give more exit options.

Tips for first-time LC users

1. Use your bank's trade finance team: They will help draft the LC. Tell them what you're buying, from where, and what documents you need — they'll structure it properly.
2. Start with a simple Sight LC: Don't complicate things with usance, transferable, or revolving LCs on your first transaction.
3. Require an inspection certificate: This is your only protection against wrong/defective goods being shipped with compliant documents.
4. Get your supplier's bank details upfront: You need the advising bank's SWIFT code and address for LC issuance.
5. Budget 2% for LC costs: Factor this into your landed cost calculation when comparing LC vs. T/T pricing.
6. Have your customs broker ready: Once documents are released, you need to move quickly to avoid demurrage.

Bottom line

Letters of Credit are expensive, slow, and bureaucratic — but they solve a real problem: how to conduct a $50,000+ transaction with a stranger across an ocean. The cost of an LC (1-2%) is insurance against losing your entire order to fraud, non-shipment, or dispute. Use LCs for new relationships and large orders, then transition to T/T as trust builds. And always — always — include an independent inspection requirement in the LC. Documents prove shipment happened; inspection proves what was shipped.

When you do move to T/T: Don't let your bank's FX spread eat into your savings. Traditional bank wires to China/Asia typically mark up exchange rates 2-4% above mid-market. On a $50,000 transfer, that's $1,000-2,000 lost to hidden fees. Wise Business uses the real mid-market rate with a transparent 0.4-0.7% fee — saving you more than the LC cost you just eliminated.