Credit unions typically charge lower interest than banks for the loans they give to members. At the same time, they pay higher interest than banks on the investment products they offer. With them taking in less money and paying out more, many people wonder how it is they can make a profit.
History of Credit Unions
According to the Credit Union National Association, the first credit union was a co-op formed by a group of weavers in 1844. They pooled their capital in order to get better prices for their materials. The idea spread, first to Germany in 1850, to Canada in 1901, and to the United States in 1908. The idea evolved from business cooperation to unions pooling resources and finally into the structure we know today.
Structure of Credit Unions
Credit unions are not for-profit entities. They pool the money of their members in order to invest that money and get better interest than their members could earn on their own. Some of that money is loaned to members at good rates, and some of the money is invested outside the organization. They operate very much like banks, except that they are run by and for the members rather than a board of directors and stockholders.
Although credit unions do not operate to make a profit, business reality requires them to cover their business expenses, including salaries and overhead, in addition to their costs of obtaining capital. And federal regulations require them to keep an operating reserve to ensure that they have enough cash to cover withdrawals and loan failures. In order to do that, each credit union must make more money than it spends.
Credit unions, like other forms of banks, perform a careful balancing act between the interest rates on their loans and the interest rates on their accounts. Money goes out to each member based on the interest on savings, CDs and other interest-bearing products. Money comes in from the interest on loans made to members, most commonly mortgages, credit lines and auto loans. Much of the operating reserve comes from the small margin between the money spent and the money earned on interest for and from members.
Many credit unions also use the pooled money of their members to invest in outside entities such as mutual funds, government bonds and currency. The rate of return from the combined spending power far outweighs the possible returns from the individuals. The combination of this investment income and interest from member accounts is what creates the profit margin for credit unions.