What is a Usance Letter of Credit?

A usance letter of credit is a financial instrument that sets the terms and conditions for the payment of a debt at a specific date in the future. Typically, the terms and conditions found within the letter of credit will cover details such as the mode of payment used to settle the debt, the total amount owed at the time of settlement, and the name of the beneficiary. It is not unusual for the letter of credit to be accompanied by supporting documents, such as an invoice for the total amount due for payment, and even a time draft that can be processed on the agreed-upon date.

While a usance letter of credit may carry a due date of any duration agreeable to the parties concerned, documents of this type usually include a date that is no more than six months from the date that the letter of credit is issued. This makes the letter of credit a useful financial tool for meeting short-term needs, allowing the recipient of the letter to obtain the credit needed to finance a specific project and hopefully generate enough return from that project to settle the total amount due within the time frame allotted. As with most types of debt instruments, usance letters can be settled in advance if the recipient is able to do so, often with no types of penalties involved.

There are benefits to a usance letter of credit that help to set it apart from other types of debt instruments. In many cases, the amount of interest that is paid by the recipient is lower than with short-term business loans. At the same time, the benefit of being able to draw on the line of credit immediately means an influx of cash that can be used for a specific project, such as the launch of a new product. If that product begins to generate returns within the projected window of time, those proceeds can be used to settle the letter of credit, without the need to tap into other company assets to finance the launch or settle the debt.

One example of how a usance letter of credit may be used effectively is with a business that experiences shifts in income levels during specific seasons. The business may obtain the letter of credit as the means of managing company expenses during a slow season. With the due date timed to coincide with the return of higher business volumes and increased cash flow, the business is able to retire the debt within terms without any apparent difficulty.