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.
How Credit Unions are Structured
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.
How Credit Unions and Banks Differ
Credit unions are significantly smaller in size than most banks and are structured to serve a particular region, industry, or group. For example, Wells Fargo has over 8,800 branches and 13,000 ATMs across the country, while the Navy Federal Credit Union (NFCU)—the largest credit union by asset size in the U.S., open to members of the military—has about 300 branches and well over 500 proprietary ATMs, with many near military bases. 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. Counting this network, as well as their own, Navy Federal Credit Union members have access to over 52,000 ATMs nationwide, for example, more than four times the number of Wells Fargo ATMs.
While credit unions and banks generally offer the same services—such as accepting deposits, lending money and offering financial products (credit and debit cards, certificates of deposit (CDs), etc.)—there are key structural differences that affect the ways in which the two types of institutions make money. The biggest difference is that banks function to generate profits for their shareholders, while credit unions operate as not-for-profit organizations designed to serve their members, who also are de facto owners.
For banks, the need to deliver profits to the bottom line usually results in more and higher fees, lower returns on deposits, and higher lending rates than credit unions. 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/owners. In this paradigm, the process credit unions use for generating revenue benefits the members who have accounts with the institution, rather than shareholders focused on profitability.
How to Join a Credit Union
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.
How Credit Unions Have Evolved
Credit unions originated in Rochdale, England, in 1844 when a group of weavers established the Rochdale Society of Equitable Pioneers. They raised the capital to buy goods at discount prices and passed the savings along to their members. Friederich W. Raiffeisen, considered to be the founder of the modern credit union, established the Heddesdorf credit union in Germany in 1846. Credit unions were introduced in Canada in 1901 and finally came to U.S. in 1908: The St. Mary's Bank Credit Union in Manchester, N.H., was the first.
Today, credit unions have become extremely widespread; many are virtually national in scope. Some, known as Federal Credit Unions (FCUs), operate under federal financial regulations rather than state banking laws (despite the name, they are not actually run by the federal government).
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—sometimes to the consternation of traditional retail banks.
Credit Union Philosophy
The objective of a credit union is summed up in the saying, "not for profit, not for charity, but for service." Since their inception, credit unions have run according to a philosophy that has come to be known as the "Seven Cooperative Principles for Credit Unions." These principles are as follows:
- Voluntary Membership: All credit union members join on a voluntary basis and there is no discrimination of any kind among potential eligible members.
- Democratic Member Control: Each member has one vote and all are equally able to participate in making decisions and creating policy.
- Economic Participation of Members: Credit unions are owned and therefore controlled by members, each whom will benefit proportionately according to the number of transactions in which he or she is involved, as opposed to the amount of capital that is deposited.
- Autonomy and Independence: Credit unions are independent organizations. Any association or dealings with an external organization or other entity must be done via popular democratic consent.
- Education, Training, and Information: Credit unions have a mission to educate and train their volunteer board members and administrators and also to provide financial education to their members and the public at large.
- Cooperation among Cooperatives: Credit unions must endeavor to work together to achieve common goals at all levels of organization, including locally, statewide, and nationally.
- Concern for the Community: Credit unions have an interest in creating policies that help sustain the development of their immediate communities.
Credit Union deposits are not FDIC-insured, but are backed at the same level ($250,000 per account type, per individual) by the National Credit Union Share Insurance Fund (NCUSIF).
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 resulting from their status as nonprofit organizations.
- Credit unions are exempt from paying corporate income tax on earnings.
- 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 a member money on loans, accounts, and savings products.
Better rates on CDs and Money Markets
According to annual data released on June 29, 2018, the national average rate for five-year CDs offered by credit unions was 1.97%, compared to an average rate of 1.62% at banks. Money market rates at credit unions were also higher, with an average rate of 0.17% versus the average bank rate of 0.13%. While these differences sound small, they do add up, giving credit unions a significant advantage over banks when competing for deposits.
Lower APRs and Fees on Credit Cards
Again, like banks, credit unions make most of their money by using the deposits held on account to fund loans with higher rates than the interest they pay out on CDs, money market accounts and, in some cases, checking accounts.
The not-for-profit status works in the favor of members here, too. A credit union typically offers credit cards with lower APRs and annual fees than a bank, as well as more generous terms on personal loans, home equity loans, and mortgages. For example, as of March 2018, the average rate on credit cards offered by credit unions was 11.71%, compared to the average bank credit card rate of 13.13%.
Cheaper Auto Loans
The biggest difference in rates between credit unions and banks is in auto loans. The average interest rate on 36-month used car loans originated at credit unions was 3.10%, as of June 2018. The average rate for the same loan through a bank was 5.19% – a hefty 60% more.
Disadvantages of Credit Unions
As mentioned earlier, 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 breadth of services, technology, and accessibility.
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.
While credit unions they 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.
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 (9 to 3, Monday through Friday), though the larger ones, such as SECU, have a 24-hour customer service hotline.
Even so, consumers often report a higher sense of community and friendliness when dealing with credit union employees, along with more intelligent and efficient service. Credit union tellers are often trained to learn the names and preferences of members and, in general, the whole client experience feels more personal.
Are Credit Unions FDIC-Insured?
The Federal Deposit Insurance Corporation (FDIC) does not cover credit unions. However, the National Credit Union Administration (NCUA), established in 1934, regulates federally chartered credit unions like 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 type of credit unions may be covered by either a state agency or private insurance.
Credit Union Tax-Exempt Status
Congress made a variety of financial institutions exempt from paying corporate taxes with the Federal Credit Union Act in 1934. Credit unions are also exempt from most state taxes. That status was reaffirmed in IRS code in 1951, while Congress removed it for some other institutions. In 1979, the IRS explained why credit unions deserved special treatment:
- They help lower-income people who might otherwise be unbanked.
- Their customer based is restricted (they have a common bond, such as a locale or trade).
- They avoid high-risk investing that seeks to generate high returns. Rather, they earn money on smaller personal loans.
As of 2019, the IRS estimates that the tax-exempt status of credit unions costs about $3 billion per year. That figure is expected to rise to $3.2 billion by 2020. Some industry watchers fear the tax-exempt status that credit unions enjoy could be under threat, as they expand their member bases and consider allowing profit-seeking institutional investors, mutual funds, or hedge funds to invest in them. Some credit unions have even bought commercial banks, which removes the latter from the income tax rolls.