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Peer to Peer lending in Nigeria and how it works

July 1, 2020 by Finance Writer

Peer to Peer lending in Nigeria

When we think about lending, most times our minds drift to the options financial institutions offer. However, peer to peer (P2P) lending is something that most of us have engaged in at some point in our lives. We call it the “borrow scheme” or “can I see” scheme. You know, “can I see N500,  I’ll give you back by tomorrow…”  

P2P lending is the same concept, however, to define it we can say that: Peer-to-peer (P2P) lending is a form of microlending that enables individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman

Types of P2P lending

Peer funded for Individuals

This type of P2P loans is usually funded by regular individuals and peers. These individuals invest in credit financing and earn returns based on interest charged on the loans.

Group Peer funded

Slightly different from individual funded credit. They are funded by a group of people, usually high net worth individuals through hedge funds, bank endowment funds, etc. Large investors fund this type of personal loans through peer-to-peer lending platforms. 

The major difference between the two types is the amount of money involved. Group peer funded loans deal with higher amounts of money than individual funded. 

How P2P lending works in Nigeria

Though the concept of p2p is familiar, the organizations pioneering its progress in Nigeria are fairly new. FINT, Farmcrowdy, and Kia Kia are at the forefront of driving this lending system. These organizations partner with individuals who act as investors on the back end while packaging these loans for the recipients who are in need.

These organizations do the hard work of running credit history as well as setting up certain criteria to make sure that these back-end investors are protected. 

Peer to peer lenders typically processes loans in two ways:

Firstly, your application is updated usually for days allowing potential investors to review your application. 

Investors then fund your loan, based on your application, by offering a portion of the total amount requested. If your request reaches 100 percent funding or at the expiration of the listing time, you may accept or decline the loan. 

Secondly, P2P lenders fund your loan is by approving your application and getting the required funds from a stock of blind investors. In this type of funding,  investors don’t review your application individually and you do not have to wait for your loan to be funded. 

What are the requirements for P2P lending in Nigeria

Criteria will differ based on the specific organization, however, listed below are some general requirements: 

  • The borrower must be a salary earner
  • must have a national means of identification, 
  • bank account statement for the last 6 months (salary account), 
  • employment offer letter, 
  • a recent utility bill (not older than the last 3 months). 

Benefits of P2P lending

Benefits of p2p lending are, but not limited to:

  • Access to interest lower rates
  • Quick turn around time on application decision
  • Transactions are very transparent, including any fees imposed by the p2p platform
  • Can be more flexible than traditional loans

Conclusion

Next time you need an instant loan, think of p2p lending as an option, based on some benefits discussed, it could be a viable option to meet your needs. 

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Filed Under: Building Credit

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4 items on a credit report that discourage lenders

June 13, 2020 by Finance Writer

Credit report

Doing all the right things like making loan repayments on time doesn’t guarantee a top credit score. When you apply for an online loan, and lenders come back with a higher interest rate or tell you to ask again later – how does that feel?

Please be aware, and it’s not only late or missed payments that diminish your credit score or make lenders cautious of you. If you’re applying for a personal loan, there are other things on your credit report that lenders examine.

However, it isn’t just new applicants who are examined. Periodically, lenders review their current customers’ to assess the risk level of the borrower to the business at a given time.

Here are the top four credit items that make lenders wary—and how to avoid them.

  1. Too many loan applications in a given time

There is no problem with opening a new loan account with your bank or taking out a revolving credit facility. But applying for loans in three to four online loan apps or banks in a short space of time in the bid to stay out of debt could be a sign of desperation. Also, opening two or three new credit facilities could tell lenders you’re in a bit of financial trouble. 

At the very least, you’ll be attracting attention the next time you ask your bank for something.

  1. Being a guarantor

When you co-sign a loan as a guarantor or in any other capacity, the entire debt reflects on your credit report. As far as lenders are concerned, you’re the owner of the debt until it is fully settled. It will be included in your debts when applying for any form of credit.

So before co-signing a loan for a friend or family member, tell them the implication of making such commitments to a loan obligation that is not yours. If you are taking out a loan soon, then you should avoid co-signing another person’s loan as a guarantor.

  1. History of partial repayments

While making partial repayments is good to avoid loan defaults, it affects your credit report negatively. Lenders who see your habitual nature of making partial payments monthly will be reluctant to grant you credit.

Occasionally making partial repayments doesn’t signal a problem. For example, you are making partial payments in January, after the holidays. But consistently paying partially every month shows you can’t pay off the balance. 

  1. Lots of hard credit enquiries. 

For every time you apply for a loan, the lender will request a credit report on you. The impact of credit report inquiries varies by the borrower, credit score and the number of confirmed inquiries. Many people don’t realise that too many enquiries on your credit report can negatively affect your credit reports. Enquiries can be made on your credit report even when you are requesting a “buy now, pay later” on a cellphone. So be sure they’re only done when absolutely necessary. 

Conclusion

It is crucial to note that there are big red flags of credit reports, like bankruptcy, foreclosure and late or missed payments. But those are not the only financial mishaps that make banks wary of a potential consumer. 

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How To Refinance Your Loan

June 13, 2020 by Finance Writer

Loan refinancing means taking out a new loan to clear one or more outstanding loans. Borrowers usually refinance their loans to receive low-interest rates or to reduce their repayments ultimately. Taking out personal loans to merge your debt can affect your finances positively and help you stay debt-free. 

However, once you’ve been granted a personal loan and your monthly repayments are on time, you may consider refinancing the loan.

It is a smart move if your credit score has improved significantly to a stage where you’ll be offered a rate reduction to compensate for commitments and cost of taking the loan.

When is the best time to refinance your loan?

  • Better credit score: One way to be eligible for a lower interest rate on your personal loan is to boost your credit score. If your score has seen an improvement since you took out your loan, it could be a plausible reason to refinance.
  • You want to change the existing rate type: Having a variable interest rate on a personal loan makes it difficult to plan for monthly repayments. By opting to refinance your loan, you can switch from a variable to a fixed rate. It enables you to enjoy consistent monthly payments.

How to refinance a personal loan

  1. How much money do you need?

In refinancing a loan, you’re primarily clearing out the existing loan with a fresh one that has different repayment conditions. Find out the exact amount of money you need to pay off your existing loan. You can also ask if any prepayment fees might exceed the benefits of refinancing.

  1. Check your credit score and report. 

Before considering refinancing your loan, you must confirm if you are eligible for a lower rate than what you’re paying currently. If the new interest rate isn’t notably lower, it may not be worth it. Alternatively, check your credit score to know if there is a difference.

  1. Do your research

Research is crucial when you are considering refinancing personal loans. It’s worth it to see what different lenders offer and their requirements. You might also need to consider the time factor, a new loan with a lower interest rate isn’t always better if you’re making repayments for a longer time.

  1. Compare refinance rates

Always compare refinancing rates and pay attention to every rate presented. Draw a table to compare key features and interest rates. Then, based on your research and your discussions with the lender, decide what’s best for you.

Advantages of refinancing a personal loan

  • Better interest rate: Not only could a jump in credit score help you get a better interest rate on a new loan in Nigeria, but you might also enjoy lower rates in your transactions generally.
  • Faster repayment of loans: When you’re convenient with higher monthly payments, and you want to pay your debt faster, you can refinance a personal loan to get a shorter term. It reduces the cost of interest payments on the loan.
  • Extend your repayment period: If you are having difficulty in making timely payments, extending your loan repayment can help you manage your monthly repayments better. 

Disadvantages of refinancing a personal loan

  • Payment of extra fees: Whenever you are granted a new loan, you might have to bear additional lender cost, which can cut into the benefits of refinancing. Be sure you understand the terms and conditions of your personal loan refinance to help you make the best financial decision.

Conclusion

Taking a refinancing option on your personal loan might be a good idea. However, you need to be careful and with clarity when choosing to refinance other sensitive loan options like a mortgage. 

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Filed Under: Building Credit

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What Is Credit Risk

June 10, 2020 by Finance Writer

It might be impossible to know if a lender will not be able to meet contractual obligations due on loan even after a rigorous and lengthy assessment. However, managing credit risk can reduce the severity of a potential loss. The reward for the lenders taking on these risks is gained from the interest charged on the loan

What Is Credit Risk

It is a possible loss resulting from a borrower’s inability to make payments of a loan or meet his/her contractual obligations. Simply put, it is a risk that a lender faces on the possibility of not receiving the owed principal and interest. The risk results in an interruption of cash flows and higher costs of collection. 

Types Of Credit Risk

There are typically three types, and they are:

  1. Default risk arising when the borrower is not able to pay the principal loan amount due
  2. The risk resulting from the reduction in the risk rating of an issuer
  3. Credit spread risk occurring due to inconsistency in the variance between interest rates in investments and the risk-free return rate.

Credit Risk Management

After the economic meltdown in 2008, many companies realized that there is no such thing as a “big company” if you do not make enough provision for risk assessment. Even if your business is safe, you might be connected to some risky businesses in which their downfall could ultimately lead to yours.

As a result, businesses have to adhere to strict legislation as well as heightened requirements for accountability and risk management. In the last decade, credit risk has grown to become a strategic sustainability measure.

The Benefits of Credit Risk Management

The significant advantage of credit risk management is to mitigate risks arising from credit transactions which will ultimately reduce risk. They can also include the following.

  1. It allows you to identify potential clients that may come at too high a risk and above your risk tolerance
  2. It can be leveraged as a strategic opportunity
  3. It is also able to improve the overall performance of the business substantially as well as give the business a competitive advantage

How To Mitigate Credit Risk

There are several ways you can use to reduce your risk to the barest minimum. Some of them are mentioned below and they are: 

  1. Check the credit records of a potential customer thoroughly. Starting with credit scores which can give you an indication of the kind of risk your potential customer is carrying.
  2. Build a long term customer relationship with the client
  3. Your agreement with your customer must be in clear terms. Be sure to draft your lending terms and condition 
  4. Establish a credit limit for a potential customer
  5. Having a standard policy as to dealing with overdue payments can also go a long way. 
  6. You can opt for the credit insurance to your advantage. Here, the insurance company becomes liable to pay the debt if the borrower defaults.

Conclusion

Credit risk is also closely related to an investment’s return, the most common example being that the yields on bonds strongly correlates to their intended credit risk. The higher the risk, the higher the interest rates demanded by investors for lending their capital. As loan companies in Nigeria get very discouraged with customers having low credit scores.

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What is Credit Score and how does it work?

June 9, 2020 by Finance Writer

A credit score is an evaluation used by financial institutions to describe a loanee or consumer’s (Individual or Corporation) creditworthiness. A higher credit score depicts a reliable and credible borrower. A credit score is determined by the credit history of the borrower, which entails several open accounts, repayment history and total level of debt. Credit scores are used by lenders to determine the probability that a borrower will repay their loans.

How does Credit Score work? 

The credit score play’s a key role in a lender’s decision to give loans. A borrower with a lower credit score infers that a financial institution bears more risk loaning such borrower. A high credit score is considered good as it makes the interest rates of loans reduce; and also makes the application process for a letter of guarantee easy. Therefore, a high credit score may result in a loanee receiving lower interest rates on a loan. 

Sometimes credit scores are also used to determine the size of an initial deposit required to get several kinds of loans. Lenders also used credit scores in deciding the interest rate or credit limit on a credit card.

In Nigeria, the credit scores of financial institutions will vary depending on the institution. 

Factors that affect Credit Scores

We’ll look at 5 factors to consider when calculating a credit score, they are:

  1. Payment History: This amounts to about 35% of how a credit score is evaluated. It shows whether a person pays their obligations on time such as bills. It is used to determine the possibility of a borrower whether they will be late in repaying their loans based on how promptly they settle bills.
  1. The total amount owed: This is the second most influential factor of the credit score. It amounts to 30% of the credit score. It refers to the percentage of available credit that has been borrowed by the loanee. It is used to determine who can handle debt responsibly. 
  1. Credit History: The credit history is used to examine the length of the time an account has been opened and the most recent action on an account. Accounts with a long credit history stand will score higher credit scores than accounts with minimal or no credit history at all. Those without a long credit history can still score higher on their credit scores if there are no missed payments and outstanding debts. 
  1. New credit: New credit refers to the number of credit accounts a borrower has. Lenders often carry out a credit report on borrowers. A borrower who as opened credit accounts and applied for too many loans will score lower on the credit score. 
  1. Types of credit: Types of credit also known as the credit mix is used to examine borrowers with a good mix of account types involving credit and instalment loans. A borrower with an existing credit account demonstrates experience in managing credit and may likely score higher credit score.

How to Improve your Credit Score

Make payments on time

Endeavour to make your payments on time, and if you have down payments to make.

Review of Credit Reports

Reviewing your credit reports helps to know what is benefiting you. You can request your credit report from your financial institution, then you can run a personal assessment to see what may help or potentially hurt your score.

Use Credit Monitoring to Track Progress 

Using credit monitoring services is a simple way to monitor credit score changes over time. These services monitor changes in your credit report, such as a paid-off the account or a new account opened.  Credit monitoring also helps to prevent identity fraud.

Limit Request for Credit Inquiries

The number of requests you make for new credit should be minimal. Too many requests for credit is known as hard inquiries. For example, if in the past you’ve requested for a new credit card loan, car loan, mortgage loan or some other form of a loan, it can negatively affect your score. A lender could interpret the borrower is facing financial difficulties and therefore be a bigger risk to the lender.

Pay off Debts and maintain a low balance on Credit Cards.

Borrowers with high credit scores often have very low credit utilization ratios. A low credit utilization ratio illustrates that you aren’t in debt and haven’t maxed out your credit cards. It shows that the borrower is likely to know how to manage credit well as lenders can be wary of loanees with low credit scores.

Diversify accounts

You may consider opening new accounts to add to your credit mix.

Conclusion

A good credit score makes a lender consider you highly for a loan in Nigeria. It also helps you get the best interest rates when you intend to loan. Since you never can tell well you might be needing a loan, it is wise to ensure that you’re as good as possible by regularly checking your credit report, having a positive payment history, having low balances on your credit cards and minimal inquiries for credit. 

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Letter Of Guarantee

June 6, 2020 by Finance Writer

A letter of guarantee is an agreement issued by a bank on behalf of a customer or company who proposes to acquire goods from a supplier. Don’t confuse this with Letter of Credit, though.

The letter assures the supplier of payment on behalf of the customer, even when the customer of the bank defaults.

It is applied for by a customer. After the bank evaluates the risk and they are comfortable, they will back the customer with a letter of guarantee.

Basics of a letter of guarantee

These letters are used when a party in a transaction is uncertain that the other party involved can meet a financial obligation. They are usually used in purchases of expensive equipment or other property.

They are used in a wide variety of business situations such as declarations during export and import processes, and sometimes in contracting and construction. The bank negotiates how much they will cover with their customer.

When is a letter of guarantee required?

  • New Supplier

Suppliers change contracts often with several customers. Therefore, customers are likely to provide a supplier with a letter of guarantee since a new supplier won’t have a history of transactions with the new customer. The uncertainty that exists between the two parties will require a letter of guarantee. 

  • Trade outside usual Trading Area

For businesses that take place overseas, you may need a letter of guarantee to show commitment to pay for products. This often happens among import and export businesses, suppliers of goods outside a country may require assurance from a bank that they will receive the fees should clients cannot pay.

  • Startup Company

Some start-up companies may not have the funds to finance the purchase of goods at the start. They may require a letter of guarantee when purchasing goods.

The Process for a Letter of Guarantee

The following process is followed:

  1. Examining and Issuing a letter of guarantee

When an application for a letter of guarantee is filed, a bank determines whether the customer qualifies for the transaction. This is done by reviewing the underlying deal, the customer’s credit score and other relevant material. Additional information or documentation from the customer may be required.

  1. Fees.

The fees for the transaction are determined by using the principles and rates as stated by the regulations of the bank.

  1. Amendment of letter

The letter may be amended by the involved parties to include the adequate requirements of parties. The subject of Amendments consists of the underlying asset, validity period and so on.

  1. Compensation against a letter of guarantee

When a supplier has supplied goods or rendered services to the customer and make claims for compensation from the assuring bank, the bank notifies the customer of the request. The bank then examines the claim and certifies that they meet the required claim clauses of the letter. If they are met, payment is made to the supplier for the stipulated amount agreed.

  1. Post-Guarantee Management

The bank updates its customer’s record to reflect changes when the bank has made payment to the supplier. The details of the letter are stored ad verified to ensure that it reflects the actual transactions.

Conclusion

A letter of guarantee is used when parties (buyers and sellers) or business, and customers do not want to make a trade credit agreement. A letter of guarantee is a promissory letter that protects and prevents the financial risk of a supplier or producer. 

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Credit: 5 Cs of Credit

June 6, 2020 by Finance Writer

In finance, the creditworthiness of a lender determines how worthy a lender is of a loan in Nigeria. A person’s creditworthiness is what creditors or lending institutions look at before they approve a loan or credit.

Several factors determine the creditworthiness of a person, such as payment history and credit score. The Five Cs of credit are the five methods of evaluating a borrower for a loan. It also considers information about the loan. Let’s look at the five Cs below:

Character

Character refers to the credit history of a borrower. This is a track record of the borrower for repaying debts since history is the best predictor of the future. Lending institutions demand a certain amount of management or ownership experience. A lender will review the personal credit of borrowers and their guarantors before a loan is granted.

Data gathered from these reports help lenders evaluate a borrower’s credit risk.

Most lending institutions require a minimum credit score before they approve a loan. This will vary depending on the financial institution. The higher the credit score of a lender, the higher the likelihood of being approved. The credit score of a borrower is also used to determine the rates and terms of loans.

Conditions

The interest rate and amount of principal affect the conditions of a loan, it influences the desire to approve a loan. Conditions may also include how a borrower intends to use the credit. Other conditions, such as the state of the economy or legislative changes, also affect the terms of the loan.

Capacity

The potential of a borrower to repay a loan is what capacity measures. This would entail the cash flow of a borrower. A borrower should have sufficient cash flow to get a higher credit score. Lenders may inquire about the time a borrower has been employed or the number of years in business to ensure stability.

Capital

Lenders consider the capital a borrower puts forward towards any investment. For example, if you were to purchase a car and you have put up a down payment of over 50% of the cost of the vehicle needing only about 50% to 30% loan, lenders are more likely to score such borrower higher on the credit score. This shows that the chances of default by the borrower are low. A substantial down payment can also affect the rates and terms of an applicant’s loan.

Collateral

Collaterals help loan applicants secure loans. They are used as leverages in case a borrower defaults on a loan. Loans that are secured by some form of security are usually offered with lower interest rates and contain better terms than other unsecured types of loans. The lender capitalises on the assurance that if a borrower defaults, the lender can recoup their loss by repossessing the collateral.

Conclusion

Understanding the fives Cs of credit is crucial to your approval of a loan. It helps a borrower prepare their credit score ahead of a loan application. Default in one area can affect your credit score from a lender.

Financial organizations attempt to reduce the risk of lending to borrowers by performing credit analysis on individuals and businesses applying for credit or loan. So, with the Five Cs, you should work on improving your credit score, and endeavour to save up for larger down payments to give you higher chances for a loan.

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Who Is a Creditor?

June 3, 2020 by Finance Writer

A creditor is that person or institution that provides credit by giving another the chance to borrow money that will be repaid in the future. Alternatively, a business who provides supplies or services to a customer without immediate demand of payment is also considered a creditor. This is based on the fact that a client owes the entity money for services or products already enjoyed.

There are two fundamental types of creditors, and they can be classified as either personal or real. Personal creditors are people who loan money to family and friends. While Real creditors such as microfinance banks or any other financial institutions have a contractual agreement with the borrower, this arrangement gives the lender the right to claim any of the debtor’s genuine assets if they cannot pay back the loan.

Different Forms of Creditors

In general terms, a creditor is synonymous to a supplier. This could be a person, organisation or any other entity that sells products or services. This means that all wholesalers and retailers could be creditors because they are into selling their products or services.

Another example of a creditor relationship is if you take out a loan to buy your house. Then the bank who holds your mortgage is the creditor. As such, if a person or entity has given out money as a form of a loan, then they are a creditor.

Usually, anyone could be a creditor depending on the kind of transaction that triggered the lender and borrower relationship. Each creditor has a stipulated agreement with their borrowers about the terms and conditions of the loan contract.

How Do Creditors Make Money

With the prevalence of loan companies in Nigeria nowadays, you may wonder how they make money. They make money by charging interest on the loans they offer their clients. For example, if a borrower receives a loan for the sum of N5,000 with 10% interest rate, the lender makes money due to interest on the loan. In return, the creditor faces a risk that the borrower may not be able to repay the loan. To reduce risk, most of them factor their interest rates or fees into the borrower’s credit score and past credit history. As a result, being a responsible borrower is essential and could save you a deal of trouble getting a loan, particularly if you are taking out a jumbo loan. 

Borrowers with quality credit scores are considered low-risk to potential creditors, and as a result, these borrowers are rewarded with low-interest rates. In contrast, they consider borrowers with weak credit scores as high risk, and to mitigate the risk, they are charged with higher interest rates. 

 

What Happens When The Borrower Defaults?

The creditors are often posed with the challenge of repayment when granting loans. If a borrower does not make repayments as at when due, they have a variety of options. Personal creditors who cannot recover a debt may be able to claim it as gain on their income tax return. This incentive can only be effected after they must have attempted to recover the debt. Banks can take over collateral used to secure the loan such as homes and cars. They also have the option of taking loan defaulters to court over unsecured debts or engage a third-party to buy or recover the debts on their behalf. 

Conclusion

However, if a borrower declares himself bankrupt, the court duly notifies the creditor of the proceedings. Sometimes, the borrower’s assets are sold to recover the debts and paid in order of their priority. Unsecured loans such as online loans are given the least priority, giving banks the smallest chance of recovering their funds from borrowers during bankruptcy proceedings.

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Insurance Loans – Everything You Need To Know

May 24, 2020 by Finance Writer

If you need quick cash and you have run out of options, the one place to look for such emergency loans is your insurance policy. Although it is important to note that you can only take out loans on permanent life insurance policies which is available either as a Whole Life Insurance or Universal Life Insurance

While taking a loan from a life insurance policy can be an easy way to get cash when you need it. There are some specifics to know before you decide to take up a loan on your insurance policy.

How Insurance Loan Works

These loans work slightly different from a bank loan or credit card. Insurance loans do not affect your credit score, unlike other types of loans, and they eliminate the process of approval from the credit bureau since you are borrowing from yourself. When you take a loan in Nigeria on your insurance policy, you need not explain how you intend to use the money. You can use for anything, ranging from bills payment to vacation expenses or an emergency. 

Also, tax authorities don’t recognise the loan as an income, and as a result, it is free from tax. However, it is expected that a policy loan will be paid back, and interest is also payable on these loans. Though the interest rates are usually much lower than the interest payable on bank loans, and there is no required monthly payment upon the borrower.

Paying Back the Loan

Even with all the accumulated benefits of taking out a loan on a life policy, the loan needs to be paid back promptly. This is because of interest accrued on the loan amount on regularly, and it doesn’t stop your mandatory monthly obligation of premium payment. Interest is attached to the loan balance and accrues regardless of when bills are being paid either monthly or not. This could result in putting your loan at risk of exceeding the policy’s cash value. In the event the insurance policy lapses, you must pay taxes on the cash value.

Insurance companies would naturally provide many opportunities to keep the loan current and prevent the insurance policy from lapsing. In the event the loan balance is not paid back at the time of death of the borrower – then the loan balance plus interest will be deducted from the amount the beneficiaries are to receive from the death benefit.

Conclusion

In summary, you should keep the following takeaways in mind whenever you want to opt for a loan on your life insurance policy

  • Taking a loan on your life insurance policy can be an easy way to get an emergency fund when you need it.
  • You can only take out a loan on either permanent or whole life insurance policy.
  • Policy loans are always taken against the borrower’s death benefit, and the insured use the policy as collateral for the loan.
  • Insurance companies (the lender) will add interest to the loan balance, which accrues whether payment is made monthly or not.
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Letter of Credit – Everything You Need To Know

May 1, 2020 by Finance Writer

In international trade, the relationship between the importer and exporter can result in a conflict of interest. This is because both parties are prone to risks of engaging in overseas transactions. To avoid business scams, the two parties need to come to a compromise by agreeing on one method of payment.

What is Letter Of Credit

A letter of credit is a commercial instrument designed to facilitate the movement of goods by providing protection and finance to the buyer and seller. You should not confuse this with the Letter of Guarantee.

Parties To A Letter Of Credit

letter-of-credit

There are five major parties to a documentary letter of credit, and they are as follows;

  • The Importer or Applicant – This is the initiator of the letter of credit. He pays the Naira cover when the loan is due, including bank charges. To do this, the bank must rank such applicant as creditworthy, and he also provides collateral before he gets the credit.
  • Issuing Bank – The Issuing Bank is the bank that opens a credit (i.e. importers bank). The issuing bank advises details to the correspondent bank. The bank guarantees payment to the exporter and thus is primarily liable on credit.
  • Advising Bank – The advising Bank receives details of the credit from the issuing Bank and issues the same information to the beneficiary. The exporter who acts according to the details of the instructions will only be paid on presentation of the substantiating document. The advising bank is also the receiving bank.
  • Confirming bank – the confirming bank can sometimes be the advising bank. The confirming banks are the banks that confirm the letter of credit in issue by the issuing bank
  • Exporter or Beneficiary – The exporter is the beneficiary of the documentary letter of credit and is responsible for keeping to the terms and conditions of the credit. If the documents are in order, he is sure of the payment immediately for sight bill.

How Letters of Credit Work

A letter of credit is a document you generate from a bank that guarantees payment transactions. There are various kinds of letters of credit, and they provide the security needed for carrying out operations.

  • Seller protection: If a buyer is unable to pay a seller, the issuing bank that raised and issued a letter of credit will pay the seller. The seller must meet all requirements in the letter of credit. This provides security when the buyer and seller are in different countries.
  • Buyer protection: In the case of buyers. If you pay someone to provide a product or service and they are unable to deliver, you might be able to receive payment using an anchor letter of credit. The amount can be a fine to the company that was unable to deliver, and it’s equal to a refund. You can pay someone else to provide the product or service needed with the money you received

Information Provided By an Applicant

The applicant for the letter of credit has to complete a form. The information needed by an applicant includes the following;

  1. State whether the credit is to be revocable or irrevocable
  2. The name and address of the ex[porter or beneficiary
  3. The amount of credit and the currency involved.
  4. The maturity date of the credit
  5. The last shipment date
  6. How the credit is to be advised 
  7. Description of the goods or services
  8. The documents which will be required to be produced

Conclusion 

The Letter of Credit is a kind of credit that a person who indulges in international trade gets. It is a conditional guarantee of payment by the bank given that the exporter fulfils certain conditions. The underlying conditions are certain before payment can be effected. Before you enter into a business transaction with an overseas customer, it is better to include it into the conditions. This puts both the buyer and seller at ease and secures their exposure to each other.

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Filed Under: Building Credit

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