Credit union loans versus payday loans

For most people who need a small sum quickly, a credit union loan costs far less than a payday loan. Interest on a credit union loan is capped by law at 3% a month, an APR of 42.6%, and many credit union loans cost about 1% a month on the reducing balance, an APR of 12.7%¹. A credit union is a not-for-profit financial provider owned by its members, and it will only lend what you can afford².

The trade-off is access and speed. You have to be a member first, and membership depends on sharing a "common bond" with the other members, such as living or working in a certain area or working for a particular employer³. Some credit unions will lend as soon as you join; others ask you to save for a set period first⁴. Payday lenders, by contrast, must check your creditworthiness before they lend, roll over a loan or increase your credit, and they can decide quickly, but at a much higher cost⁵.

This page sets out what a credit union loan costs, how much you can borrow, who can join, whether you need savings first, how to apply, what happens if you fall behind, and where to complain if something goes wrong.

Credit union loans are a cheaper alternative to payday loans

Credit unions are named by debt charities as one of the alternative borrowing options to payday loans, alongside budgeting loans, bank overdrafts and salary advances⁹. Independent guidance describes them as a more affordable alternative to banks or expensive payday loans, sometimes offering cheaper loan rates¹⁰. Their stated aim is to provide loans at low interest rates¹.

The gap in cost is the main reason. A credit union cannot charge more than 3% a month by law, and many charge about 1% a month on the reducing balance¹. The cap was raised to 3% a month by the Credit Unions (Maximum Interest Rate on Loans) Order 2013, which came into force on 1 April 2014 and increased the limit from 2% a month⁸. Before that, the limit had been 1% a month, inclusive of all administrative costs and other expenses¹¹.

It is worth being precise about what a credit union loan is not. It is not always the cheapest loan on the market: credit union loans are often more expensive than personal loans from a bank or building society¹². The comparison that matters here is with high-cost credit. A Government-commissioned study in 2013 found that credit unions offer the best value to consumers on loans up to £2,000¹³. For someone weighing a payday loan against a credit union loan, that is the relevant benchmark.

There are limits to what a credit union can do. A credit union is not a bank and cannot offer overdrafts, mortgages, electronic banking services and payment methods or business loans in the same way as a bank¹⁴. If you need a large sum or a mortgage, a credit union is unlikely to be the right route.

What a credit union loan costs: capped at 3% a month

The legal maximum is the anchor. The Credit Unions (Maximum Interest Rate on Loans) Order 2013 increased the maximum interest a credit union may charge on a loan to 3% per month, and the rate specified for the purposes of section 11(5) of the Credit Unions Act 1979 is three per cent per month⁸. Official guidance for Great Britain confirms that the maximum interest a credit union may charge on loans is 3% per month¹⁵.

In practice, many charge much less. Many credit union loans cost 1% a month on the reducing balance of a loan, an APR of 12.7%¹. The cap is a ceiling, not a price.

One consequence of the cap is that credit unions are limited by law in how much interest they can charge, which is why the regulator has pointed consumers who want to avoid high-cost credit towards them¹⁶. The other side of that coin is that credit unions are exempt from certain rules and regulations that apply to other financial services providers, and most of the loans they provide are specifically exempt from the Financial Conduct Authority's Consumer Credit sourcebook¹⁷. That exemption is why the affordability standards applied to credit union loans are typically lower than those imposed on lenders and loans covered by that sourcebook¹⁷.

For a borrower, the practical effect is this: the price is capped and usually low, but the protections that come with regulated consumer credit do not all apply in the same way. More on what does protect you is below.

How much you can borrow and what it can be used for

Credit unions lend small amounts for all purposes, and some can lend larger amounts over longer periods, for example to buy a car or for home improvements¹³. Most credit unions lend small loans of around £50 to £3,000¹⁸. One official source describes credit unions providing loans starting from £50⁴. Independent guidance puts personal loans at up to about £3,000, adding that credit unions are happy to offer much smaller sums¹.

The amount you can borrow is often tied to what you have saved. If you are a member of a credit union, you can usually borrow at least two or three times the amount you have in savings, depending upon the loan policy of your credit union⁷. The same rule is repeated across debt advice guidance for England and Wales and for Scotland¹⁹. Credit unions are saving schemes run by their members which also allow you to borrow two or three times as much as you have saved at a low interest rate²¹.

Two things follow from that. First, the more you have saved, the more you can typically borrow. Second, the credit union will only lend what you can afford, and it always considers affordability when assessing loan applications⁴. Members' savings are used to fund loans to other creditworthy members, so the pool is finite²².

Who can join: the common bond

All credit unions in the UK may only accept members who have a "common bond"²³. That bond can be based on where you live or work, the type of occupation you have or your employer²³. In practice it typically means a credit union is either based in a local community or its members work in the same sector, for example the police²⁴. Members tend to have to have something in common, such as their profession²⁵.

The bond is broader than it sounds. It can mean working for a particular employer or in a particular industry, or simply living or working in a specified geographical area¹³. Anyone in the house of a person with a common bond with a credit union can usually join¹. If one member of your family is already a member, other relatives living at the same address can usually join too²⁶. If a credit union's rules allow, it may have more than one common bond²⁶.

Eligibility has been widening. Changes will widen eligibility to include students, local workers and relatives of existing members, reflecting the way people live and work²⁷.

Do you need to save before you can borrow?

Often, yes, at least a little. You need to be a member of a credit union to get a loan from them, and some will ask you to build up savings first²⁸. Some will lend to you as soon as you become a member, while others will only lend after saving for a set period¹³. You usually need to have a history of saving with a credit union before you can borrow long-term loans and mortgages²⁹.

The saving requirement is not usually large. You can choose to save as little or as much as you can afford³⁰. If you join a credit union and start saving with them, you will also be able to apply to borrow money once you have proved you are a reliable saver³¹. Joining normally means being asked to pay a small fee, for example £2, or saving a certain amount such as £10³.

This is the structural difference from a payday loan. A payday lender lends against your next payday; a credit union builds a relationship with you as a saver first, then lends. That takes longer, but it also means the loan is sized against what you can afford rather than what you expect to receive.

How to join and apply for a loan

To become a credit union member, you need to visit or call your chosen credit union to confirm what information you need to join¹³. You will usually need to provide two recent documents to prove your identity and address, for example a passport, driving licence, student or work ID card, bus pass, birth certificate, bank statement or energy bill³.

The website www.findyourcreditunion.co.uk can help you locate credit unions¹⁵. Credit unions deliver their services in different ways: online and phone banking, a payroll partnership with your employer, a local branch or service point you can walk into, or a combination of all three³⁰.

If you are finding it difficult to get credit, independent guidance suggests seeing if there is a credit union in your area instead, or checking whether you can borrow from the Social Fund³³. Credit unions are also suggested as an option to consider when shopping around for a funeral loan³⁴.

What happens if you miss a repayment

The most important difference from a payday loan is what the credit union can do with your savings. If you miss payments on a loan, the credit union may be able to use your savings to repay the loan¹⁹. That is a real risk to plan for: the money you have built up is not ring-fenced while you have an outstanding loan.

Credit unions are also expected to help. They might offer to reduce or pause your payments for a limited time, stop adding interest to the loan for a limited time, or help you work out a plan to pay what you owe²⁶.

Compare that with a payday loan. If you miss a payment to your payday loan it will be recorded on your credit reference file¹⁸. You owe the outstanding balance, plus added interest, extra fees and charges³⁵. Missing payments can lead to extra charges and can negatively impact your credit score, and it could also make it harder to get credit in the future⁹. A default usually happens after you have missed between three and six months' payments³⁶.

If you are struggling, free and impartial help is available from MoneyHelper and from debt advice charities such as StepChange and National Debtline. If a creditor harasses you, Citizens Advice sets out what you can do³⁷.

Protection and complaints: FSCS cover and the Financial Ombudsman

Loans and savings with a credit union are protected by the Financial Services Compensation Scheme⁸. That matters if the credit union itself fails. Note that credit insurance is not eligible for FSCS protection, so if you are offered insurance alongside a loan, check what it covers³⁸.

If something goes wrong with the loan itself, you can take your complaint to the free Financial Ombudsman Service if you are unhappy with the final response or the timeframe has passed³. The ombudsman is a free, informal alternative to the courts with a duty to resolve financial complaints based on what is fair and reasonable³⁹. It can help with complaints about bank accounts and bank cards, insurance for your home, car or travel, and problems with loans⁴⁰.

The ombudsman sees complaints about unaffordable lending across a range of credit products, from car finance to payday lending¹⁷. Its complaint scope covers payday loans, the affordability of the lending, and being unhappy with the quality of goods bought or hired with credit⁴¹.

Where the rules differ across the UK, it matters here. Credit union finders are listed separately for England, Scotland and Wales, and for Northern Ireland³. Debt advice guidance is published separately for England and Wales and for Scotland¹⁹. If you are in Northern Ireland, the payday lending rules and guidance are set out separately⁵.