Q&A: Credit unions

What are credit unions for?
They are community-based financial cooperatives which are owned and run by their members. They allow members to save and borrow with them at decent rates of interest, crucially, giving people on lower incomes access to lower-cost credit.

Are they open to everyone?
Each credit union will have a "common bond" which determines who can join, and these will vary from one organisation to another. Some will be for people living or working in one area or working for one employer and others will be set up for members of an association, such as a church or trade union.

How do they work?
Members pool their savings together and this pot of money is used to provide loans to applicants in that group. The savers are paid an annual dividend on their money, the income is generated by interest paid on loans, and any profit is shared among the members - there are no shareholders to pay.

Is it an ethical option then?
In many ways, yes. Firstly, the principles behind credit unions mean that they will never invest in arms-trading companies or pornography, as other financial services companies might.

But another reason people like to invest in credit unions is that they know who will reap the benefits, depending on the common bond that union has. They give people on low incomes an alternative to the crippling rates of interest and fees that many unscrupulous lenders will charge them.

They also work with their members and often aim to "empower" them by giving financial education. They offer facilities for people without bank accounts to pay for utilities in a cost-effective way.

Indeed, the FSA is keen to extend the remit of credit unions, with the hope of using them to help reduce financial exclusion.

What kind of deals do they offer?
On the savings side, credit unions pay an annual dividend on savings, which can be up to 8% of the amount saved, but is more typically 2 or 3%. Account holders can deposit money in any amounts and whatever instalments suit. The unions generally have depositing facilities set up at local shops or collection points, and it's sometimes possible to have sums taken direct from wages.

For borrowing, by law, credit unions can't charge their members more than 1% a month (which works out at 12.7% APR) on the reducing balance of the loan. So if you borrowed, say, ?1,000 over a year, you would repay no more than ?1,067.

Because of the nature of them though, many credit unions charge less interest than that. Most credit unions can make unsecured loans with terms up to three years, and secured loans over up to seven years. "Version two credit unions" are authorised to lend for up to five years, unsecured, and up to 15 years, secured. They are neve allowed to charge penalties for early repayment.

Credit unions offer life savings and loan protection insurance for free. On a member's death, his or her savings can be doubled by the insurance and paid to whoever the member has chosen. With loans, if a borrower died before the loan finished, it would be repaid by the insurance.

Is it safe to borrow and save with credit unions?
Since July 2002, credit unions have been regulated by the Financial Services Authority - the same as with banks and building societies - and all staff and volunteers have to be FSA-approved. They are also members of the Financial Services Compensation Scheme, which means that if a credit union was to fold, savers would be compensated as they would with banks and building societies. This amounts to 100% of the first ?2,000 in savings and 90% of the next ?30,000. If members have grounds for complaint and the do not get any satisfaction from the credit union's own complaints procedure, they can go to the Financial Ombudsman Service.