What is a Credit Union? How do They Differ From Regular Banks

The term credit union refers to cooperative financial institutions that are managed and owned by their members.  They are often closely monitored and regulated similar to other financial institutions. Typically, a credit union provides services to a group of people who share some common interest (like a workplace), who reside in a certain area, or visit a common church.

Credit unions range in size from volunteer-only and small-scale operations to huge organizations that have thousands of members. Credit unions can be created by large companies, business entities and other organizations for their members and employees.

Credit unions are usually set up with the aim of providing a convenient and secure place to their members where they can save funds and secure loans at affordable rates. They are more prevalent in areas where there is a large portion of low-income groups. Credit unions operate by utilizing the accumulated savings of their members for raising finance that can be lent to other members at reasonable interest rates.

As the funds are in a sense given to the credit union on “rent”, members enjoy a stream of regular income in the form of dividends on the money that is given. A credit union operates in a systematic manner and aims to maximize the benefits for its participants.

Credit Unions vs. Conventional Banks

A credit union is different compared to a traditional bank and other financial institutions. The main difference is that banks and other similar financial institutions are profit making business entities that work principally for the benefit of their stakeholders. On the other hand, credit unions tend to share profits and earnings among their participants via dividends.

Another key difference is regarding the design of control and ownership. A bank is controlled and owned by its stockholders whose primary aim is to get a suitable return on the funds they have invested. In contrast, a credit union is operated and managed by its members through boards of directors who plough back the union’s profits, or give members a share of the profit. As the main purpose of the existence of credit unions is the benefit and welfare of its participants, there are occasions when all profits are reinvested, which allow credit unions to lend funds on lower rates of interest.

Credit unions are relatively small as compared to most banks and financial institutions, and are designed to render services to a certain region, group or industry. For instance, Wells Fargo, which is one of the largest banks in US, has more than 8,800 branches and over 13,000 ATMs throughout the US. In contrast, the Navy Federal Credit Union, which is the biggest credit union in the US, is only open to people who have a military background and has only 300 branches.

How to Join a Credit Union

In order to carry out any business transaction with a credit union, you have to become a member or participant by opening an account as you would do in case of any commercial bank. Once you open an account, you become a partial owner and a member of that credit union. This means you can take part in the affairs of the credit union. You get the right to vote in determining the composition of the board of directors and in decisions that may affect the union. Unlike banks, a member’s voting rights depend on their level of investment, but rather each vote is equal.

The Evolution of Credit Unions

Credit unions were initially formed in Rochdale, UK, in 1844 when a small number of weavers set up a society called Rochdale Equitable Pioneers. They generated finance to purchase stock at reduced prices and later passed their gains to their participants. Friederich Raiffeisen, deemed by many as the founder of credit unions, formed the Heddesdorf credit union in 1846. Credit unions then made their way to Canada in 1901 and eventually came to the US in 1908 when the first US based credit union was set up in New Hampshire.

Nowadays, credit unions have cropped up in huge numbers in all parts of the country. Many have a national scope, while others, called Federal Credit Unions (FCU), conduct their operations under financial regulations issued by federal authorities instead of state banking rules and laws. Initially, membership in credit unions was restricted to individuals who had a “common bond”, such as working for a particular company or in a certain industry or, or residing in the same region or community.

However, recently credit unions have relaxed their restrictions with respect to membership, and are allowing the public to become participants, often to the dismay of conventional  banks.

The Largest Credit Unions

1. Navy Federal Credit Union   Vienna, VA manages $55.5B in assets and has 4.79 Million members.
2. State Employees Credit Union    Raleigh, NC manages $28.3B in assets and has 1.90 Million members.
3. PenFed Federal Credit Union     Alexandria, VA manages $17.6B in assets and has 1.30 Million members.
4. BECU     Tukwila, WA manages $12.6B in assets and has 858K members.
5.  Schools First Federal Credit Union     Santa Ana, CA manages $10.3B in assets and has 600K members.The top 50 largest credit unions can be found here

Credit Union Philosophy

The fundamental goal of credit unions can be summed up in this popular saying, “not-for-profit, not-for-charity, but for service.” From their inception, credit unions have operated according to a well-defined philosophy, which has the following characteristics:

• Credit union participants join them voluntarily and there is usually no discrimination of any type when choosing potential members.
• They are democratically organized as every member has one vote and all have the right to participate in the decision making process.
• A credit union is owned and controlled by its participants. Each participant receives benefits on a proportional basis depending on the volume of transactions in which they are involved, and not on the basis of the amount that they have deposited.
• Credit unions have autonomy and are therefore independent entities and any dealings or association with an external party or other organization has to be approved by democratic consent.
• Credit unions usually adhere to a mission of educating and training their volunteer administrators and board members and increasing their financial literacy.

Pros of Credit Unions

Similar to banks, the mechanism of generating or raising funds in credit unions begins by attracting and securing deposits. In this respect, credit unions tend to enjoy two distinct advantages over conventional banks that stem from their non-profit status. Firstly, credit unions are exempt from on their earnings, which is a huge advantage. Secondly, credit unions are only required to make sufficient earnings to finance their day-to-day operations.

Therefore, they tend to have narrower operating margins compared to banks, and shareholders expect these margins to boost earnings on a quarterly basis. This ability to operate with relatively narrow profit margins enables credit unions to pay higher  rates of interest on deposits, and at the same time, charge low fees for various other services they offer, like ATM withdrawals and checking accounts.

Similar to banks, a credit union makes most of its money by utilizing the deposits to fund loans with higher interest rates compared to the interest rate they pay on call deposits, money market deposit accounts and, in a few situations, checking accounts. However, here again, the nonprofit status of credit unions works for the benefit of its participants. A credit union tends to offer credit cards that charge lower APRs and annual costs compared to conventional banks, and also offers more generous terms and conditions on home equity loans, personal loans and mortgages.

For instance, as of March 2017, the average interest rate on credit cards charged by credit unions was 11.54%, in comparison to bank’s average credit card interest rate of 12.82%. In addition, late fees and balance transfer charges are also low compared to those charged by most conventional banks. Plus, clients often report a greater sense of friendliness and community when they deal with employees of a credit union, and are also satisfied with more efficient and intelligent service.

Credit unions often train their tellers to get familiar with the preferences and names of their clients, and overall, the entire customer experience is more personal.

Cons of Credit Unions

Credit unions tend to have fewer brick-and-mortar locations compared to a majority of banks out there, and this can be an inconvenience for customers who prefer personalized services. Although many credit unions offer modern services, like auto-bill pay and online banking, a majority of small credit unions usually can’t afford the latest technology, which big banks easily fit into their budgets. As a result, the security and website features are often less advanced in terms of technology.

Moreover, compared to banks, credit unions offer considerably fewer choices in terms of financial products and related services. For example, Bank of America offers over 20 different credit card choices, which range from student cards to reward cards. In contrast, NFCU offers just five options.

As banks have greater resources, which they can allocate to their personnel and customer service, they are open for longer hours and now operate on Saturdays. Credit unions, on the other hand, have the tendency of maintaining traditional business hours (9 am to 3 pm, Monday through Friday), though a few larger ones, like SECU, do have a customer service hotline, which is functional 24 hours a day.