Credit unions: what are they and how do they work?

Could a credit union be beneficial to you? Offering community savings and loan cooperatives, credit unions can give lower interest rates and encourage people to save money.

As a not-for-profit entity, the focus is on supporting members rather than paying out to shareholders.  

To be a part of a credit union, you must share a common bond with other members. This can be based on things like location, or an employer.

With an array of benefits, it’s worth learning about the advantages that saving with a credit union can offer – particularly as the cost of living rises.

This way, you can establish whether it’s an option that works for you.

What is a credit union? 

A credit union is a financial cooperative that offers members a range of traditional banking services such as savings and loan accounts.

With your money saved in a credit union, you and other members pool your savings together to lend to each other; it is run for the benefit of members, rather than as a money-maker.  

Each individual credit union sees its members united by a common bond. This may be that they live in the same area, belong to the same trade union or work for the same employer.

Due to the community-run nature of credit unions, they can be small or large in scale, and are exempt from tax.  

How does a credit union work? 

The model for credit unions is fairly simple. Members pool their money together in what is technically then ‘buying shares’ in the cooperative.

This pooled money can then be used to provide loans, demand deposit accounts and other financial services, all for the benefit of members.

Credit unions run on a not-for-profit basis, so any income that is generated is injected back into projects and services that serve the community and members of the credit union.   

Borrowing money from a credit union

To get a loan from a credit union, you first need to be a member.

A major advantage of borrowing from them is their low interest rates, which are legally capped.

In England, Scotland, and Wales, the maximum rate is 3% a month (42.6% APR), while in Northern Ireland, it is 1% a month (12.68% APR).

This makes credit unions a much fairer and more affordable alternative to payday loans or high-cost credit, especially for smaller loan amounts.

One of the biggest barriers for people seeking a loan from a standard bank is a low credit score.

Credit unions are often more flexible and can look beyond just a credit score, meaning they may offer borrowing opportunities that normal banks would not.

If you have been turned down for a loan elsewhere, a credit union could present a viable alternative.

Saving with a credit union 

Saving with a credit union offers flexibility, allowing members to save ‘what you can, when you can’.

You can deposit money via direct debit, have it deducted from your wages, or pay in at a local branch or collection point.

Crucially, your savings are protected. All UK-regulated credit unions are part of the Financial Services Compensation Scheme (FSCS), which protects your money up to £85,000 per person, per institution.

This is the exact same level of protection you get from a traditional bank or building society.

As a saver, you may also receive a yearly dividend.

This is a share of the credit union's profits, and the rate will vary depending on how well the cooperative has performed that year. 

Advantages and disadvantages of joining a credit union 

As with most financial decisions, there are pros and cons of joining an credit union.

Advantages of joining a credit union 

• Lower fees: Thanks to the not-for-profit model of credit unions, they offer the attractive benefit of lower fees and charges than you might expect from a traditional bank 

• Lower loan rates: Similarly, credit unions can also offer lower loan rates, which are capped across the UK at varying degrees  

• Personalised service: Since credit unions serve a specific community, members can expect a far more personal service than one offered by a national or international bank. They likely go above and beyond to look after members, and offer support with their individual financial needs 

• Community investment: Your credit union membership will mean you’re part of a community. With this in mind, the profit made by your credit union is paid back into your community, helping to directly impact the lives of members for the better  

Disadvantages of joining a credit union 

• Exclusivity: Not everyone can be a part of a credit union. Since they are founded around specific communities, you’ll need to find one that you are eligible for 

• Accessibility: The benefits of a community-based service also have the downside of limited accessibility. You may not have the ease of ATMs and branches where you can readily deposit cash, unless your credit union is part of a shared branch network. And while banking is becoming increasingly digital, credit unions may also be slightly behind in their tech offering; unlike big banks, they may not offer mobile apps or online banking 

• Service restrictions: Although credit unions often provide a wide range of services, each is different in what it offers members – meaning you may still need a bank service for some everyday needs  

How to join a credit union

To join a credit union, you can use search tools such as FYCU to help you find one that you are eligible for.

You then need to contact them to confirm the information required to join, and they will likely offer you more details about the application process.

Most credit unions have a website that offers contact details, and many offer online application services.  

How do I know if I’m eligible to join a credit union? 

You will be eligible to join a credit union if you meet a certain set of criteria, also known as a ‘common bond’.

Each credit union has a different common bond, so you’ll have to look into this as part of your research process.

However, you will not be restricted based on your financial situation.  

In the face of a financial downturn, more people are seeking ways to protect their money.

Doing so is easier with expert help, so let us help you find your perfect financial adviser today.