What Is a Credit Union?

A credit union is a type of financial cooperative that provides traditional banking services. Ranging in size from small, volunteer-only operations to large entities with thousands of participants spanning the country, credit unions can be formed by large corporations, organizations, and other entities for their employees and members.

Credit institutions are created, owned, and operated by their participants. As such, they are not-for-profit enterprises that enjoy tax-exempt status.

Understanding Credit Unions

Credit unions follow a basic business model: Members pool their money—technically, they are buying shares in the cooperative—in order to be able to provide loans, demand deposit accounts, and other financial products and services to each other. Any income generated is used to fund projects and services that will benefit the community and interests of its members.

Key Takeaways

  • Credit unions have fewer options than traditional banks, but offer clients access to better rates and more ATM locations because they are not publicly traded and only need to make enough money to continue daily operations.
  • However, credit unions have considerably fewer brick-and-mortar locations than most banks, which can be a drawback for clients who like in-person service.
  • Credit unions are exempt from paying corporate income tax on their earnings.

Requirements for Membership

Originally, membership in a credit union was limited to people who shared a "common bond": working in the same industry or for the same company, or living in the same community. In the recent past, credit unions have loosened the restrictions on membership, allowing the general public to join.

To do any business with a credit union, you must join it by opening an account there (often for a nominal amount). As soon as you do, you become a member and partial owner. That means you participate in the union's affairs; you have a vote in determining the board of directors and decisions surrounding the union. A member’s voting ability is not based on how much money is in their account; each member gets an equal vote.

According to the National Credit Union Administration, membership in federally insured credit unions grew to 108 million in the first quarter of 2017, an increase of 4.2% from the first quarter of 2016.

Advantages of Credit Unions

Like banks, the process of making money at credit unions starts by attracting deposits. In this area, credit unions have two distinct advantages over banks, both resulting from their status as nonprofit organizations:

  1. Credit unions are exempt from paying corporate income tax on earnings.
  2. Credit unions need to generate only enough earnings to fund daily operations. As a result, they enjoy narrower operating margins than banks, which are expected by shareholders to increase earnings every quarter.

Being able to work with narrow margins allows credit unions to pay higher interest rates on deposits, while also charging lower fees for other services, such as checking accounts and ATM withdrawals. In short, a credit union can save members money on loans, accounts, and savings products.

Credit unions offer better rates on CDs and money markets.

According to National Credit Union Administration (NCUA) data released on Dec. 28, 2018, the national average rate for five-year CDs offered by credit unions was 2.35% (on a $10,000 deposit), compared to an average rate of 1.89% at banks.

Money market rates at credit unions were also higher, with an average rate of 0.32% (on a $2,500 deposit) versus the average bank rate of 0.23%. While these differences sound small, they do add up, giving credit unions a significant advantage over banks when competing for deposits.

Disadvantages of Credit Unions

Credit unions have considerably fewer brick-and-mortar locations than most banks, which can be a drawback for clients who like in-person service. Most offer modern services such as online banking and auto-bill pay. Still, the small size of many credit unions can mean a compromise in a breadth of services, technology, and accessibility.

Lower Tech

Smaller credit unions typically do not have the same technology budget as banks, so their website and security features are often considerably less advanced. That said, some mid-sized and larger credit unions may offer mobile banking apps that rival those of much bigger for-profit institutions.

Fewer Options

While credit unions offer most of the financial products and services that banks do, credit unions often provide less choice. Bank of America has 21 different credit card options, ranging from rewards cards to student cards, while NFCU has only five. The second-largest credit union in the country, the State Employees’ Credit Union (SECU), offers one credit card.

Less Flexibility

With more resources to allocate to customer service and personnel, banks are keeping later and longer hours: open until 5 or 6 PM on weekdays and often on Saturdays, as well. Credit unions tend to maintain traditional bankers' business hours (nine a.m. to three p.m., Monday through Friday), though the larger ones, such as SECU, have a 24-hour customer service hotline.

Credit Unions vs. Banks

Credit unions are significantly smaller in size than most banks and are structured to serve a particular region, industry, or group. However, just because most credit unions have fewer branches does not mean they cannot have a reach similar to that of big banks. Many credit unions are part of an ATM network designed to expand their reach.

A credit union can also save members money on loans, accounts, and savings products.

While credit unions still must make enough to cover their operations, the absence of the need to generate profits generally allows for lower fees and account minimums, higher rates on savings, and lower borrowing rates for their members and owners.

Special Considerations

The Federal Deposit Insurance Corporation (FDIC) does not cover credit unions. However, the NCUA, established in 1934, regulates federally chartered credit unions as the FCU mentioned above, and those with headquarters in Arkansas, Delaware, South Dakota, Wyoming, or the District of Columbia. The NCUA's Credit Union Locator can verify whether a credit union is federally chartered.

One of the NCUA's main responsibilities is to administer National Credit Union Share Insurance Fund (NCUSIF), which uses federal monies to back up shares (deposits) in all federal credit unions.

The NCUA provides coverage for each individual account, joint account, trust account, retirement account (such as traditional IRAs, Roth IRAs or Keogh plan accounts), and business account for up to $250,000 per account. For example, if you have an individual account, a Roth IRA, and a business account at a federal credit union, your total shares are insured up to $750,000.

Credit unions without the word "federal' in their name, or headquartered in states other than those listed above, are state-charted. Shares in these types of credit unions may be covered by either a state agency or private insurance.