Traditional banks and credit unions are both options when considering where to secure your money. What are the pros and cons of each and which should you choose?
When you think of a bank, the traditional bank probably comes to mind first. As of 2016 there were 5,082 FDIC insured commercial banks in the USA according to data published by the St. Louis FED. These commercial banks offer services to the general public and businesses. They accept your deposits and allow you to maintain checking and savings accounts. Commercial banks will use your deposits to make loans and generate profits from the loans they issue. These loans include auto loans, mortgages and business loans. Traditional banks are usually privately owned and operated.
The Federal Deposit Insurance Corporation (FDIC) provides insurance on your banking deposits. The current maximum amount insured in $250,000 per depositor, per account. This means that, in the event your bank fails, the FDIC will insure your deposits up to this maximum amount. The FDIC was created by President Franklin Roosevelt in 1933 as part of the Banking Act of 1933 and was designed to protect consumers in the event of a bank failure and increase confidence in the banking system. Prior to the creation of the FDIC, many consumers experienced hardships as banks failed during the 1920s and 1930s. FDIC insurance is provided for each account you have at a bank, but the insurance does not extend to investments such as mutual funds, stocks or ETFs. Today, the FIDC insures nearly $9 trillion in deposits!
Interest on Bank Accounts
The interest rate on your account will dictate how much you are earning on your deposits. Banks pay interest to depositors because they are using your money to lend to other consumers and businesses and you should be compensated for this use. Interests rates vary by bank and it’s possible to find higher rates from online banks or other banking institutions such as credit unions. Typical rates at a traditional bank are around 0.01%. Some online banks offer rates up to 1%. Depending on your preferences and needs, going with an online bank may be advantageous. Traditional banks tend to offer different rates depending on the account you establish and the balance you carry. For example, a savings account may offer only 0.01%, but a Money Market Account with a high balance may offer 0.05%.
APR vs. APY
When you open a savings account or take out a loan you may hear about two different rates: APR and APY. These figures are not equal and knowing what they are will help you make a wise decision on the type of account to open or loan to accept. An important concept to understand before delving into APR and APY is compounding. At its essence, compounding is the interest you earn on previous interest. In finance, this is a very powerful factor and can make your savings grow or result in paying a lot more for a loan than you thought.
The annual percentage rate (APR) is the annual rate of interest and does not take into account the compounding factor for a year. You can determine the APR by multiplying the rate per period by the periods in a year. For example, a loan charging 1% per month would have an APR of (1% x 12) = 12%.
The annual percentage yield (APY) differs from APR in that is does account for compounding. You can calculate APY with the following formula: (1 + Periodic Rate)# of periods – 1. Looking at our previous loan with 1% per month the APY would be (1 + 1%)12 – 1 = 12.68% per year. As you can see, if you only looked at APR you wouldn’t get the true cost of the loan for a year.
When you go to take out a loan it’s important to calculate the APR and APY to understand the true cost of your loan. Banks will usually quote you the APR, so knowing how to calculate the APY will make you a more informed borrower and save you money in the long run.
Credit Unions fill the same need as traditional banks in that they accept deposits and make loans. The difference is that credit unions are not for profit and are organized to serve their members. Unlike a traditional bank where anyone can open an account, you must be accepted to a credit union. Members of a credit union are able to borrow and save at reasonable rates, typically better than a traditional bank. Becoming a member of a credit union may be possible if you are part of a select group, such as military personnel and their families.
- Credit unions are organized and operated to serve their members. Superior service and better rates are a big plus.
- Lower balance requirements, or no requirements, can be very helpful for those individuals who cannot maintain the balances required at traditional banks.
- Credit unions are exclusive. You must be a member of a specific group to join, so a general consumer is not able to join.
- With better rates, credit unions haven’t been quick to offer great rewards on credit cards. If paying off your balance each month isn’t a problem for you, it might be worth it to find another institution that offers better rewards.
- Restricted ATM access may cause problems. Recently, credit unions have made improvements to offer more ATM services to members, but they are still limited when compared to larger, traditional banks.
Are Credit Unions FDIC Insured?
Credit Unions are not covered by FDIC insurance, but they are protected by the National Credit Union Administration (NCUA). The FDIC focuses on insuring deposits in banks and, when you join a credit union, you don’t make a “deposit” as defined by the FDIC. With a credit union, you become a member and your “deposit” is referred to as shares. The NCUA provides insurance for your shares just like how the FDIC insures deposits. Federal credit unions are insured by NCUA and state credit unions may also be insured by NCUA or a state insurance policy.
Like FDIC insurance, NCUA also has maximum limits for each credit union member. The NCUA does insure up to $250,000 in share value per person, per credit union. Note, this will consider all your shares in a credit union, not just one particular branch. If you open an IRA, this account is also insured up to $250,000 and is independent of your other non-retirement accounts. Finally, if you have a business account with a credit union your shares will be protected up to $250,000. However, businesses must meet certain requirements as set forth by the NCUA to be eligible for this insurance.
When deciding between a traditional bank and a credit union, there are a few tradeoffs to consider and it will come down to a personal decision. No matter which institution you decide to go with, remember to consider the interest rates you are offered on your accounts and loans. Consider the convenience of branch locations and ATMs and always ask about possible fees you may encounter.
If you have anything to add please share below. As I’ve never been a member of a credit union, I would be excited to hear how those of you that are find the service and the products offered.