How Credit Unions Work

By: Dave Roos
Indian Finance Minister Palaniaffen Chidambaram speaks
Indian Finance Minister Palaniaffen Chidambaram speaks at the Revival of Rural Cooperative Credit Institutions meeting in New Delhi. Credit unions began as small, European co-ops but are now international institutions.

On the surface, credit unions look a lot like banks. They both hold deposits, make loans, issue checks and ATM cards, and offer investment services. But the real difference between banks and credit unions has less to do with the services they offer and more with how each institution is run.

Banks are for-profit companies. They make money by charging interest on loans, collecting account fees and reinvesting all that money to earn more profit. But as for-profit companies, they also pay state and federal taxes.


Credit unions, on the other hand, are not-for-profit institutions. Technically, credit unions are owned by their account holders, known as members. Any profit earned by a credit union is either invested back into the organization or paid out to members as a dividend [source: Federal Reserve]. As a not-for-profit institution, credit unions pay no state or federal taxes, meaning they can charge lower interest rates than banks for most financial services.

Credit unions were designed to be cooperative financial institutions for people who share a common bond. Members of a credit union may work for the same company or organization, attend the same college, serve in the armed forces, belong to the same church or live in the same community. Credit unions have become more popular in recent years. Nearly 90 million Americans are members of a credit union, and credit unions hold more than $615 billion in savings. Worldwide, there are more than 46,000 credit unions with about 172 million members [source: WOCCU].

But the growth of credit unions has met strong resistance from the banking industry, which sees these not-for-profit agencies as unfair competition. In 1998, the U.S. Supreme Court handed a victory to the banks, saying that some credit unions had signed on members with no common bonds in an attempt to increase their size and power [source: New York Times].

How did credit unions evolve into such powerful entities? Why does the banking industry want credit unions to pay taxes like everybody else? And with perks like free checking and low interest rates on credit cards, how do you join a credit union?


Modest Beginnings: the Birth of Credit Unions

An REA (Rural Electrification Administration) Co-Operative in Rush County. The REA is part of the New Deal legislation passed by the government of Franklin Delano Roosevelt.
MPI/Getty Images

The idea for credit unions came about in late 19th century Europe as part of the emerging cooperative movement. Cooperatives are voluntary, self-governed associations of people that work together for a common goal. The first cooperative was founded in 1844 by a group of workers in Rochdale, England. The Rochdale Society of Equitable Pioneers, as the group was known, pooled a pound from each member to open a cooperative store that sold butter, sugar, flour, oatmeal and candles.

The cooperative movement evolved into the idea of pooling member money to offer credit to individuals. The first official credit unions were founded in Germany in 1849 to save poor urban workers from resorting to loan sharks for financial help. In North America, the first successful credit unions were founded in Canada at the turn of the 20th century.


America's first credit union opened in Manchester, N.H., in 1909, but the movement really owes its early success to the work of Pierre Jay, the Massachusetts banking commissioner, and Edward Filene, a Boston businessman. Jay and Filene fought for legislation legalizing credit unions at the state level. Beginning with Massachusetts, they established credit union laws in 15 states by 1925.

Credit unions took on a new significance during the Great Depression. In 1934, President Franklin D. Roosevelt signed the Federal Credit Union Act into law. The law established a nationwide credit union system, overseen by the federal government, to help citizens with small incomes get credit for "provident purposes."

The Credit Union National Association (CUNA) was also formed in 1934 as a national organization overseeing the many existing state credit union leagues. Right after World War II, there were fewer than 9,000 credit unions in the United States. But by 1969, there were 23,876 [source: CUNA]. Due to consolidation and mergers, there are currently around 8,500 credit unions in the United States.

In 1970, the U.S. government formed the National Credit Union Administration (NCUA) to regulate all federal credit unions. The NCUA enforces operating rules on all federally chartered credit unions. The NCUA also manages the National Credit Union Share Insurance Fund (NCUSIF) to insure individual credit union accounts up to $100,000. The NCUA sets a cap on credit union interest rates for certain loans, but does not set specific interest rates -- that's up to individual credit unions.

The World Council of Credit Unions (WCCU) was also founded in 1970 to serve the ever growing international community of credit unions. Today, the WCCU has member credit unions in 97 countries, where it helps support 46,000 local credit unions through development and training [source: WOCCU].

Next, we'll look at the differences between two of the most common credit unions and where, exactly, you fit in.


Natural-person and Corporate Credit Unions

People who share an employer, such as these construction workers, are eligible for membership in a natural-person credit union.
ŠiStockphoto/Daniel Rodriguez

If you're a member of a credit union through your workplace, church, school or community, you belong to what's called a natural-person credit union. A natural person, is simply an individual human as opposed to a business or corporation.

But even natural-person credit unions rely on larger financial institutions to supply them with enough liquidity (available cash) to run their businesses. These institutions are called corporate credit unions. There are about 30 corporate credit unions in the United States, all owned by their members, which are natural-person credit unions.


Corporate credit unions, like natural-person credit unions, can be either federal-chartered or state-chartered. They're regulated by either the National Credit Union Association (NCUA) or state banking authorities.

Confused? Here's how it works. Natural-person credit unions apply to be members of corporate credit unions. Even though they're called "corporate" credit unions, they're still not-for-profit. The corporate credit unions supply natural-person credit unions with low-interest loans to keep up their cash reserves. Other services offered by corporate credit unions are investment services, credit and loan services, business checking, wire funds transfers and more.

There's even a financial institution that provides financial services for corporate credit unions -- a credit union for corporate credit unions, if you will -- called U.S. Central. U.S. Central, like all other credit unions, is nonprofit and owned by its members (which in this case are corporate credit unions). Similar to the role that corporate credit unions play to natural-person credit unions, U.S. Central provides cash liquidity and investment services, as well as risk-management and analysis services to its member credit unions. U.S. Central boasts that it manages more than $49 billion in assets.

Where do the credit union members fit into the equation? On the next page, learn how you can join a credit union and what services are available to members.


Membership in Credit Unions

Many credit unions offer free checking services -- just one of the membership perks.
ŠiStockphoto/Shannon Long

According to the Federal Credit Union Act, anyone can apply to join a credit union if he or she shares a common bond of employer, educational institution, branch of the military or government, church or community. Over the years, the growth of the credit union movement has resulted in nearly everyone being eligible for membership through some connection.

There are several ways to find out if you qualify for membership in a credit union:


  • Ask your human resources representative at work. Your employer may sponsor or have access to a credit union.
  • Ask family members (both immediate and extended) if their employers sponsor a credit union. Many credit unions allow family members, even cousins, to become members.
  • Ask friends and neighbors if they've heard of any community credit unions, either for your local neighborhood, county or city.
  • Call your state credit union league or use the online search tools provided by CUNA.

To become a member of a credit union, you need to fill out an application, many of which are available online. The first step on all credit union applications is to prove your eligibility, so be ready to provide the name of a relative, employer or organization through which you're affiliated. You'll then fill out some standard personal information questions about where you live and work and how much you get paid. After that, you can choose which financial services you want.

As we've mentioned, credit unions offer many of the same financial services as a bank:

  • Checking accounts and ATM cards
  • Savings, money market and IRA accounts
  • Credit cards
  • Secured or unsecured personal loans
  • Mortgages and home equity loans
  • Auto and recreational vehicle loans
  • Travelers cheques, money orders, certified checks and currency exchange

For many people, the main advantage of credit unions is that they charge lower interest rates for credit. The average credit union credit card charges 12.15% interest annually compared with 15.08% for the average bank credit card [source: MSN]. Plus, most credit unions charge no annual fee for credit cards and offer free checking accounts. Another advantage of credit unions is that they require very little money to open an account.

One disadvantage of smaller credit unions is that they may have fewer branch offices and less access to ATMs. Another disadvantage of smaller credit unions is that they may not offer as many services as banks.

If you're looking to join a credit union or learn more about credit, debt and personal finances, visit the links on the next page.


Lots More Information

Author's Note: How Credit Unions Work

I will be the first to admit that I am financially illiterate. One of the best parts of writing for HowStuffWorks is that it forces to understand the basics of our finance and banking systems. This article is a great example. I've probably driven by hundreds of credit unions and never once stopped to think, "What are those things all about?" Researching this article helped me understand the possible advantages of joining a credit union (lower interest rates on loans and credit cards) and the potential disadvantages (fewer branches and ATMs). I should probably share all of this useful information with my wife, since she's the one who makes all of the financial decisions (thank goodness).

Credit Unions: Cheat Sheet

  • The main difference between a credit union and a bank is that banks are for-profit corporations and credit unions are non-profit companies "owned" by the account holders.
  • As non-profit entities, credit unions don't pay state or federal taxes, allowing them to offer better interest rates than some banks. Banks see this as unfair competition and have fought credit unions' non-profit status up to the Supreme Court.
  • Credit unions are formed to serve a group of people who share something in common. Examples are: employees at a particular company, alumni of a particular school, members of a church, members of a specific community and armed forces veterans.
  • There are two major types of credit unions: natural-person credit unions and corporate credit unions. Natural-person credit unions are the ones that serve individual customers like you and me. Corporate credit unions help manage the finances of natural-person credit unions by providing loans and liquidity to the institutions. Even corporate credit unions are non-profit.
  • To find out if you qualify to join a credit in your area, ask your coworkers, friends and people in your community. Or you can contact the Credit Union National Association.

  • "After the War Years." Credit Union National Association
  • "Credit Union Community." U.S. Central.
  • "Credit Union History." Credit Union National Association
  • "Credit Unions Lose to Banks in High Court." The New York Times. 26 February 1998. 15751C0A96E958620&scp=1&sq=credit+union
  • "Credit Union Ruse." Massachusetts Banker Association.
  • "Definition of cooperatives." University of Wisconsin Center for Cooperatives
  • "Frequently Asked Questions: Banking Information." Federal Reserve Board.
  • "History of Credit Unions." Randolph Brooks Federal Credit Union
  • "How to Join a Credit Union." Credit Union National Association
  • "International Credit Union System." World Council of Credit Unions.
  • "United States of America: National Credit Union Data." World Council of Credit Unions. 2006.
  • Weston, Liz Pulliam. "Ditch Your Bank for a Credit Union." MSN Money. 16 July 2007.