Takeaways
- Credit unions are not-for-profit financial institutions owned by members.
- Credit union deposits are insured by the National Credit Union Association (NCUA).
- Credit unions are exempt from most taxes and do not have to pay corporate income tax.
- Credit unions typically provide more local ATMs than larger banks.
- Credit unions offer fewer products than banks but can offer better interest rates and low fees.
What is a Credit Union?
Credit unions are not-for-profit financial institutions that are member-owned. Credit unions focus on serving the needs of their members ahead of focusing on making a profit. With attention on its members, there is alignment between the credit union’s incentives and its members. Credit unions pass along their profit to members in the form of dividends (more on that below).
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Credit unions and banks effectively perform similar services because they accept deposits, make loans, offer checking services, and access ATMs. Credit unions allow you to keep your capital local and give unique advantages, including lower account fees and higher interest on deposits.
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How Do Credit Unions Work?
Credit unions consist of members, and the function of the credit union is to serve those members. Members of a credit union are the depositors and customers of the credit union. As a result, there is a cohesion of aligned interests. Members deposit cash into a credit union and typically pay a fee to be associated with the credit union. In turn, the credit union uses member deposits to facilitate the running of the credit union.
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When the credit union makes income or a profit, the credit union returns the profit to members in the form of lower rates on loans, higher interest rates on savings, and reduced account fees. As not-for-profit entities, credit unions are exempt from paying most taxes and don’t pay taxes on their profits [1].
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You might be wondering how credit unions and banks are similar and different. Credit unions serve their members, while banks report to their shareholders and serve customer and depositor accounts. Banks are for-profit entities owned by private or public shareholders. As for-profit entities, banks function to make a profit for their shareholders.
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Depositors and account holders at a bank are not owners of the bank. The deposits from account holders help the bank make loans and create savings and checking accounts. Banks make income on the spread between their cost of accessing capital and the difference they charge for loans. Banks are incentivized to increase this spread to boost profits and deliver a return to their shareholders. While credit unions make income similarly, they pass their profits onto members.
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Credit Union Definitions and Terms
Banks and credit unions use different terms to describe similar accounts because of the distinctions in their ownership structure. Because of this, credit unions and banks describe similar accounts and features. Below are some of the key terms used by credit unions and their parallel banking term:
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Share Draft Accounts: At a credit union, share draft accounts are essentially the same as checking accounts at a bank or other financial institution [2]. The difference in name occurs because, at a credit union, the share draft account is a form of ownership, so this account represents a “financial share” of ownership in the credit union. Importantly, you can draft from this account using checks.
Share Accounts: There are credit union accounts that don’t offer a drafting function. These accounts are called share accounts, and they function analogously to savings accounts at a bank.
Dividend: Members who hold interest-bearings accounts like a share draft account or share account don’t earn “interest”. Instead, because members are owners of the credit union, members earn “dividends” on their holdings. These dividends are basically the same as earning interest income on a checking or savings account at a bank. The difference in name only occurs because in credit unions members own part of the credit union, while account holders at a bank are simply bank customers with no ownership attached to their holding. The dividends at a credit union also represent the profits of the credit union distributed to members.
Par Value: The par value of a share draft account or share account is the same as the minimum opening deposit required for a savings, checking, or money market account at a bank.
Co-Opt: A co-opt is a collection of members that share services. For example, some credit unions that don’t offer ATMs or other services themselves belong to a co-opt of credit union ATMs. This allows members to access their funds at a variety of locations.
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Credit Union Deposit Insurance
Deposits at federally insured credit unions are protected by the National Credit Union Association (NCUA). Members’ deposits are insured up to $250,000 per ownership category established by the NCUA. This deposit insurance program functions similarly to how the Federal Deposit Insurance Corporation (FDIC) insurance works for FDIC-insured banks and financial institutions.
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Membership in Credit Unions
Credit unions usually form around a central cause. For example, credit unions may form from the commonality of geographic location, association with a labor union, or attendance to a school (e.g., The University of Texas has the University Federal Credit Union [3]).
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Depending on the credit union, you can also become a member for a nominal fee. Some credit unions will charge non-refundable dues. These fees can be worth it if the increase in interest rates offered by the credit unions is higher than local banks. Membership in most credit unions is surrounded by a common cause, making membership quite durable.
Smart Summary
Where you stash your money matters. Joining a credit union can make financial sense if you can be part of a credit union through your university, employer, or other association. Credit union membership can offer superior benefits to banks, facilitating the growth of your deposits and offering low-rate loans. You should balance these economic advantages with the ease of accessing your funds, account flexibility, and diversification of financial product offerings.
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Frequently Asked Questions
Credit unions aren’t for everyone. A national or online bank that offers high-yield savings accounts might be a better option if you are focused on convenience, technology, and diversity of product offerings.
Yes. Membership at a credit union doesn’t preclude you from opening a savings account or checking account, investing in a certificate of deposit, or taking a loan from a bank or other financial institution.
Yes and no. Dividends at a credit union represent the interest paid to members and the profit redistributed to members. If you are purchasing a publicly traded stock that pays a dividend, you are also receiving a fraction of the profit distributed to shareholders. In both scenarios, you are technically an owner. However, a credit union is a not-for-profit institution with members, while a publicly traded company is a for-profit entity with shareholders.
Sources
(1) National Association of Federally-Insured Credit Unions. Credit Union Tax Exemption. Last Accessed January 27, 2024.
(2) Consumer Financial Protection Bureau. What is a credit union share draft account? Is it a checking account? Last Accessed January 27, 2024.
(3) UT Federal Credit Union. How Do You Qualify for Membership? Last Accessed January 27, 2024.
