Key Post Credit Union loans - effective rate of interest

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Mrs Vimes

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Brendan has started a separate thread about setting credit union shares against loans here.

It occurred to me while reading it that there is an issue with the amount of interest credit unions really charge which I feel in many cases can be quite misleading.

Credit Union Loan| €12,000|interest rate 9%
Credit Union Shares|€6,000|interest rate 0%
Net borrowing|€6,000|
Annual interest: €1,080

if the shares were set off against the loan, the reduced loan would be €6,000 and the annual interest would be €540


Effectively the loan is only 6,000 so the rate of interest is 18%.

I wonder how many people would be advising others to get a credit union loan at 18% to pay off credit cards?

I understand that credit unions may only require 25% of loan amount to be held on deposit, but this would still equate in this example to 12% interest which is not any cheaper than an overdraft and probably a lot more expensive allowing for when overdraft is reduced (payday).

What do people think?

Sybil
 
Hi Mrs Vimes

It is a very interesting point.

I have argued before that the APR on CU loans is a lot higher than they quote and the standard response was "You don't understand how credit unions work, Brendan" or "You are just anti the credit union movement, Brendan".

I am not anti credit unions, I am anti 18% aprs.

Brendan
 
If you have a good job, good credit history and want to build a €50K extension to your house, the credit union would be a very very expensive place to go for that money. As you point out the interest rate is further compounded by having shares/ deposits that are inaccessible.

If you are on social welfare and you need to replace your washing machine then the credit union may be the cheapest money you can get even if the rate is 18%. I am not against a 18% APR, there are borrowers in the UK paying 2400% APR that would be delighted with 18%.

It all comes back to clarity and education/research, both individuals and institutions need to make a better effort to understand the products that they are buying / selling.
 
I agree with ontour.
When credit unions started they were local co-operatives lending small amounts It was mutual assistance. Neighbour helping neighbour. Working together for mutual benefit.
Many borrowers would not have been looked at by the banks and had to turn to moneylenders.
As for interest it is only on the outstanding balance of the loan. Certainly it seems high but the credit unions initially did not lend huge amounts. Only on recent years did they turn to competing with the banks.
I suppose it is almost inevitable that the credit unions will end up privatised as their impressive asset(cash) base will attract predators.
Then we'll all be in hands of the moneylenders ....
 
Hi Paddy

The main asset of the credit unions is loans to members and these are currently suffering a very high arrears rate, so the CUs would not be attractive.

I don't think that a CU can be privatised under Irish law.

Brendan
 
Hi Anyone

The calculation is a typical calculation where no interest is paid and the rate charged is 9% and the deposit equals half the loan.

Vary any of these, and the rate rises or falls.

You have also used a simple method of calculating the interest. 12,000 paid over 1 year in a credit union at 10% would result in the member paying interest of around 650 euro, due to interest being charged on the reducing balance.
Click to expand...

Correct. This was done for simplicity. But if you use the quoted APR and CAR of 9% and 0%, you still get 18%.

Brendan
 
Hi ontour and paddyman,

I'm not giving out about the rate of interest charged per se, as you have both pointed out credit unions provide a very valuable service to their members and certainly fill a gap in the market and 18% is not necessarily a punitive rate; many people, particularly poorer people are paying a lot more.

My difficulty is with the quoted rate of interest.

People who are trying to pay off a number of loans are generally advised to tackle higher interest loans first, and rely on quoted APR figures to determine which is the highest rate loan.

If a person has a bank loan at 10% and a credit union loan at 9% they will generally try to pay off the bank loan first, whereas this will actually cost them more in interest.

I think it is down to giving proper information. People who do have the choice to borrow from bank or credit union find it difficult or impossible to compare rates.

I have often seen advice on here to take a credit union loan to pay off a stubborn credit card whereas using credit union savings and then increasing payments would be cheaper.

I remember a woman I worked with some years ago being told by the credit union that she should not withdraw 1,000 of her 3,000 savings to pay for a holiday, she should instead borrow 1,000 and leave the savings alone. This struck me as irresponsible to encourage debt.
 
@Mrs Vimes - your example shows how credit unions do not educate people in the wise use of money and how practices induce people to imprudently use credit.

Consider an example of loan pricing:

Loan 15,000 and savings of 5,000
Term 5 years
Loan rate 10% savings rate 1% (net DIRT 0.72%)
Effective rate is what?
Say it’s the loan rate plus the opportunity cost in foregoing a market interest rate
What’s the bank rate? Well it’s the term rate applicable to the locked in savings
Say the current 5 year rate is 5%.
Effective rate = 10% of 15,000 plus savings rate of 5% (net of DIRT) = 18.6%
Before adjusting for APR

I go to my bank and it agrees to lend me €15,000 and take €5,000 in savings as security. Do I opt for a 0% rate account or do I put this into a fixed term deposit account? The bank tells me how much it will charge on the loan and how much it will pay on the deposit account. I can work out what the net cost will be. I can also arrange to have deposit interest credited to the loan account.

But my credit union will say “we might pay you a dividend on your savings if we make enough profit” and “we might pay you a rebate on the interest we charge you if we make enough profit.” Where we do pay a rebate we won’t pay it into your loan account but into your share account.

What’s it saying? We don’t know if we can pay you a return on your money and we will overcharge you on your loan – but we might be able to refund you what we overcharge you on your loan. If we do, the rebate will be paid into you share account and by the way you can’t use this or any of the money in your share account to pay down your loan faster.

If you need money at any time sure we can always top up your loan.
 
kaplan said:
........we will overcharge you on your loan – but we might be able to refund you what we overcharge you on your loan.
Click to expand...

This thread is important so that people understand the true cost of borrowing from the credit union and especially the opportunity cost of inaccessible savings on a low rate of return .

The credit union is not 'overcharging'. they quote a rate and give a rebate if funds allow, no guarantees, so a person should assume no rebate. You quote a loan rate of 10% but there is massive variation in interest rates charged by credit unions and people need to appreciate that being a member of one credit union may be much more beneficial than being a member of another especially if they have access to membership of alternative credit unions. You quote a savings rate of 1%, many currently pay 0% while others paid 4% in the last few years. The €5000 is not tied in for 5 years as the loan will drop below €5,000 between year 3 and 4 which either allows the loan to be paid off or a portion withdrawn . I am sure there are lots of other things I have missed.
 
@ontour
For a read on credit union dividends see [broken link removed]: 4% rates are long gone.

A person should of course assume no rebates and assume no dividends - someone should tell credit unions that advertise loan rates net of rebates to stop misleading their customers.

In which case the example stands - while rates may differ the fact remains with depressed dividends the effective cost of borrowing increases.
 
Kaplan,
The link you posted is dividends for last year, not sure what part you are referring to that indicates '4% is long gone'. My point was that your assumption of 1% is not universal across credit unions over a number of years and I highlighted that many are currently paying nothing.

Credit unions should not advertise net of rebates or should have to caveat it with 'past performance of rebates is not guarantee..."

Unfortunately your example does not stand as the €5k is not locked in for 5 years as you assume. The general point of accounting for the opportunity cost of the savings does stand and is important to highlight.

There is a death benefit insurance as part of the loan, you can argue that it is not optional and the customer may not want it but there is a financial value to it.

Credit union rates do not show the true cost of the borrowing. Lending decisions are based on more than cost.
 
@ontour
Introducing the canard of free life insurance is a red herring - if the insurance wasn't paid for by the credit union then it could either (a) pay a higher dividend to the living and or (b) charge a lower rate on the loan to the living.

You wrote "while others paid 4% in the last few years" - [broken link removed] as it has a chart of rates paid since 2000 - you'll notice as I said the 4% rate is long gone. The last time 4% appears is for 2008 when only 16 of 415 credit unions paid 4%. The 1% I use if of course generous given that 300 paid 1% or less last year (of these close to 100 paid nothing at all).

My example does stand as I am looking at the effective rate and calculating what that rate would be in the first year -of course rates may change over time and the bank in the example may release its secured deposit.

But let's forget about the secured nature of the bank deposit - say the bank lends the money unsecured and I put the €5k on term deposit with it. The result is of course the same in terms of the effective interest rate.

What most people do not realise is when they borrow from their credit union all of the funds they have in share accounts are automatically "attached" to the loan. Say I have €10k in shares and I get a loan for €10k - my share account is now attached and the credit union must make a decision to allow me to withdraw my money - it can do this and allow me to take €7.5k. My credit union will not state in its loan agreement what value of shares it is relying on a "security" nor will it tell me that it cannot allow the balance of my share account to go below 25% of the value of the outstanding loan. This is not what people would consider consumer friendly.

Problem is that some credit unions will refuse me transferring what money I have in my share account into my loan account - say I owe €10k and have 2.5k in my share account - well some will not allow me reduce what I owe - which is being discussed here

To add to the contortion of loans and shares - many credit unions ceased lending on multiples of share balances. A few would lend over 100% of the amount requested - if you were a new customer they would loan you an amount on top of your loan to open a share account with. For example I need a loan of €10k but am not a member. The credit union would lend me €11k, give me €10k and open a share account putting the €1k into it. Care to figure out the effective loan rate on this loan?
 
kaplan said:
@ontour
Introducing the canard of free life insurance is a red herring - if the insurance wasn't paid for by the credit union then it could either (a) pay a higher dividend to the living and or (b) charge a lower rate on the loan to the living.
Click to expand...

It is not a red herring to point out that the comparison on interest rate alone is flawed, that is the point of this thread. One the one hand is the impact of the shares/ savings that are tied in, my point is that there are other differences that are relevant to a lending decision.

kaplan said:
The 1% I use if of course generous given that 300 paid 1% or less last year (of these close to 100 paid nothing at all).
Click to expand...
Why not use an average of the last 5 years?


kaplan said:
My example does stand as I am looking at the effective rate and calculating what that rate would be in the first year
Click to expand...
I may be misunderstanding but my reading was that your rate of 5% was based on a 5 year fixed rate. Where does your 5% net of DIRT come from?

kaplan said:
But let's forget about the secured nature of the bank deposit - say the bank lends the money unsecured and I put the €5k on term deposit with it. The result is of course the same in terms of the effective interest rate.
Click to expand...

The result would be quite different as banks offer term deposits and I am not aware of credit unions that offer term deposits. The bank could guarantee you a rate on those savings for the 5 years.

kaplan said:
The credit union would lend me €11k, give me €10k and open a share account putting the €1k into it.
Click to expand...
Have you a reference for this? I am sure this would interest the regulator and put the credit union in a weak position if they had to pursue the loans through legal channels.
 
@ontour why not produce your own worked example?

I might add that certain credit unions are known to have overcharged interest which was not refunded. Seems certain IT systems in use may have had the odd glitch or two.
 
10,000 Euro for a car loan for 5 years. Comparing AIB and Gorey Credit Union. Only reason for selecting Gorey is that they were first in a google search for credit unions with online loan calculators.

Monthly Repayments on car loan of €10,000 over 5 years :
 AIB - 216.20
Gorey CU - 197.55


Now for the tricky part, factoring in the opportunity cost of the shares. I will assume 2,500 euro in shares locked away for 4 years. After 4 years the shares would be enough to pay off the loan. Use the 4 year National Solidarity Bond at 3.31% nett as the alternative to leaving the shares in the credit union. This will yield 347.80 or the equivalent of 7.25 per month. Assume that the credit union pays no dividend in any of the 4 years, then the opportunity cost per month is 7.25.

Monthly Repayments -Includes opportunity cost of inaccessible savings:
 AIB - 216.20
Gorey CU - 204.80


Notes:
Different financial institutions have different rates for different products
The products from AIB and Gorey are not identical, features of either may benefit one individual and be of no value to another person
The amount of funds that are inaccessible and the policy to seek approval to access funds varies. It may often make sense to remove funds prior to obtaining a loan as the withdrawal may not be permitted after the loan is drawn down.
 
@ontour

To be fair, you should use the same borrowing rate in your example. The AIB rate you are using is 11.15% and the credit union rate is 6.9% (I note the standard rate is 9.25%)

Mixing rates in this way in dealing with the substance of the thread is a tad misleading.

Mind you, it does illustrate that credit union loans are currently cheaper than bank term loans. Banks are quoting 11%+ for term lending whereas many credit unions appear to quote between 5.5%-10.50% for differing borrowing purposes. Now if only they could pay a decent dividend rate or deposit interest rate.

Back to the substance what’s the effective rate: Your example actually proves the point. The credit union rate while not quoted by you is 6.9% and only available at the credit union you elected to quote.

Using your example of the opportunity cost yields an effective rate of 8.60% where €2.4k is in the share account. Where €5k is left in the share account this increases to 10.60%
 
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