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					Lending to Low-Income Members And
     Underserved Communities

        by Darla Dernovsek

            April 2004
Table of Contents

Executive Summary


Meeting the Challenge

Managing Risk

Serving Low-Income and Underserved Communities


About the Author



                  Lending to Low-Income Members
                   and Underserved Communities
                                    by Darla Dernovsek

                                  Executive Summary
Lending in low-income and underserved communities is about more than just giving money to
people and then accounting for its return with interest. While the process of lending and repaying
certainly takes place, credit unions that serve low-income and underserved communities are
trying to achieve something more lasting than a single loan. They are seeking to invest credit
union funds in transforming members‟ lives by moving them along the path toward financial

Keeping this objective in mind helps credit unions stay focused on developing the policies and
procedures required to successfully manage the risk associated with offering low-income loans.
Risk-based pricing often plays a vital role in helping cover the credit union‟s higher costs and
losses from low-income lending, while enabling these credit unions to continue to offer low rates
to members who have already proven their ability to repay. Creating strategies to manage risk
can also allay regulators‟ concerns.

Serving low-income members is often labor-intensive, so credit union should anticipate higher
operating expenses at low-income branches. Grants from national organizations can help credit
unions develop products and offer education to support low-income lending. Other credit unions
often lend their support as well.

Developing the right products and services can make a crucial difference in persuading people
from low-income and underserved communities to adopt credit union services, rather than
relying on payday lenders and other “predatory” lending services. Strategies pursued by credit
unions include combating tax anticipation loans by offering free tax preparation services using
trained volunteers; working with a “payday lender with a heart” to offer micro-loans that are
facilitated by online applications and electronic transactions; and offering loan products that help
members “graduate” to lower interest rates. The ability to serve diverse populations, offer
financial education, and work with community organizations is crucial.

When credit unions successfully develop products and practices that invite residents of low-
income and underserved communities inside their doors, they give these new members an
opportunity to move toward long-term financial stability. To boil it down to one word, what
they‟re giving these members is hope.

                  Lending to Low-Income Members
                   and Underserved Communities
                                    by Darla Dernovsek

Low-income and underserved lending sometimes seems like a problem in search of a formula. In
mathematical terms, a formula is a statement that describes a logical relationship. In other words,
the formula provides a way to plug in the numbers to gain a meaningful result.

Credit unions often seem to be seeking the same assurance for lending projects aimed at low-
income and underserved members. It‟s always tempting to seek a guaranteed method for
plugging in the numbers to produce the right reaction with the right level of risk among the target
population. But in reality, the right formula for low-income lending can be an elusive equation.
There are some common variables that make a positive difference – financial education, risk-
based lending policies, pertinent products. Yet a workable answer is typically not indicated by
one or even all these factors, but by a complex mix of community conditions, regulatory
requirements, and individual credit union initiatives.

Defining low-income members
One way to define low-income members is to compare their income to the median household
income for that of the nation. In 2002, the median household income was $42,400, according to
the U.S. Census Bureau. Low-income members have a household income that falls at or below
80 percent of that figure, or $33,920. These figures can be adapted to local conditions, with
credit unions designated as “low income” if the majority of its members earn less than 80 percent
of the average for all wage earners. The NCUA provides methods to determine whether a credit
union meets low-income criteria on its web site at

Credit unions that earn low-income designation may be eligible for special grants and may
participate in the Community Development Revolving Loan Fund Program. Low-income credit
unions may also receive non-member deposits and include secondary capital in their computation
of net worth.

Defining Underserved Populations
When neighborhoods or communities contain a large number of residents whose lives could be
improved from credit union services, they may be described as “underserved.” Residents of
these underserved communities could benefit from credit union services, yet lack access to

services that are relevant to their lives. It‟s important to note that they may have access to some
type of financial institution; however, these financial institutions have failed to develop services
that help residents overcome the barriers to financial stability.

While many people who live in underserved areas are low-income, others are moderate-income
residents who may be distrustful of traditional financial services due to a lack of education or
experience. Reaching these relatively affluent residents can often help credit unions compensate
for the higher risk of serving low-income residents.

The NCUA urges credit unions to “adopt” underserved neighborhoods and communities and
gives federal credit unions the option of adding an underserved community to their service area
without a charter change. More information about serving low-income and underserved
populations is available on the National Credit Union Administration (NCUA) site at

                                Meeting the Challenge
Credit unions that meet the challenge of lending to low-income and underserved populations use
many different tactics. Cliff Rosenthal, executive director of the National Federation of
Community Development Credit Unions (NFCDCU), notes that it‟s hard to cite a common
model for success in low-income lending because these services are offered by diverse
institutions and aimed at diverse populations.

Yet there are certain tools and tactics that are often cited for their ability to contribute to the
success of low-income and underserved lending programs. The common element of these
approaches may be the recognition that low-income lending products must be designed to appeal
to borrowers. In other words, rather than changing the low-income or underserved borrower to
get them to enter the credit union, the organizations developing these approaches are willing to
change the credit union to welcome the low-income borrower.

                                      Managing Risk
Managing risk may be the most significant challenge facing credit unions that want to serve low
income and underserved communities. Federal and state regulators are likely to demand that the
credit union prove that its plans for low-income lending can be implemented without
jeopardizing its financial stability. The credit union must also be ready to demonstrate to its
board and its members that it can continue to provide excellent service to all members while it
expands its involvement in low-income lending.

Create Risk-Based Lending Policies
Risk-based pricing for lending products can make it possible for credit unions to afford the
higher risks of lending to low-income and underserved populations. With this model, members
who have a poor credit score or lack a credit history pay more for services than members with
better credit histories. Yet these prices are still less expensive than the fees charged by predatory
lenders or other types of financial services.

“Any credit union in the US can establish a risk-based loan program,” notes Edward J. Gallagly,
President and CEO of Florida Central Credit Union, Tampa, FL. The $210 million credit union
has developed a national reputation for its work with low-income lending. As of March 2004,
Florida Central has 3,800 accounts from low-income members and has issued 1,850 risk-based

Gallagly says offering risk-based loans is “like returning to Credit Union 101.” Most risk- based
loans to low-income members involve amounts of $1,000 or less, with $300, $500, and $700
being the most common amounts requested at Florida Central. Most of these loans are made at
15 to 16 percent interest, although the rate on some can be as high as 18 percent. Delinquency for
risk-based lending runs at about 1.3 percent, which compares to 0.3 percent for the entire loan
portfolio. About 12 percent of Florida Central‟s $122 million loan portfolio is comprised of risk-
based loans.

Gallagly says several adjustments are essential to effectively use risk-based lending to reach low-
income and underserved people.
    Policies and procedures should define the type of risk that is acceptable, how rates are
     determined, and how internal audits will be used to keep risk-based lending in balance
     with the overall loan portfolio.
    Approval standards should be structured to ensure every loan gets a second look.
     Members can fail to meet standard policies for approval due to poor credit scores,
     insufficient length of employment, high indebtedness, or a number of other factors. When
     a loan fails to meet approval standards at Florida Central, the application is immediately
     referred to two senior loan officers who take another look to try to find a way to approve
     the loan. These loan officers often call members to ask questions to see if there are
     grounds for making the loan. The member who has worked in her current job as a hospital
     food service employee for only six weeks may have previously worked at another hospital
     for six years, for example.
    Products should be redesigned, with an emphasis on lowering the minimum loan amount.
     Many credit unions believe that members can use their credit cards to cover small
     shortfalls or emergency purchases under $1,000. Yet these members may lack access to a
     credit card, or may only be eligible for card products that charge exorbitant interest rates.

The NCUA provides information about risk-based lending policies on its Web site at, including its Risk-Based Lending letter to credit unions

Anticipate Regulators‟ Concerns
Regulatory agencies on both the federal and state level often encourage credit unions to get
involved in efforts to serve low-income communities. Yet credit unions report that these same
regulators will scrutinize unconventional programs aimed at serving low-income populations
with a critical eye.

“They want you to do it, but by the same token you better be in good shape when you do it,”
Gallagly says, noting that problems arise if capital is low or delinquencies are high. “Your
community outreach program participants on the lending side can‟t jeopardize the safety and
soundness of the credit union.”

Again, policies and procedures aimed at managing loan risk can help satisfy regulators. Credit
unions that perform community outreach should take a proactive approach in presenting
information to examiners to help them review policies, procedures, and products in context. The
information offered should include clear objectives for products or services, including how they
will be delivered, how results will be measured, and what steps will be taken if losses or costs
exceed projections. It‟s important to prove that your credit union will be diligent in monitoring
and controlling risks related to low-income lending. Finally, the credit union should indicate how
much capital would be placed at risk through higher-risk loans. Experienced credit unions say
that risks that are capped are typically more acceptable to regulators.

Gallagly notes that credit unions that follow these practices will still be able to attain high
ratings. For example, Florida Central received five “1” ratings in its CAMEL score for its March
2004 NCUA examination.

Rufino Carbajal, Jr., President and CEO of West Texas Credit Union, El Paso, encourages credit
unions to remember that examiners who appear to be distrustful of the credit union‟s ability to
serve a low-income community are simply being true to their mission of protecting members. He
notes that one of the examiners who seemed most critical of low-income lending practices at
West Texas later wrote a letter recommending Carbajal for the prestigious Herb Wegner
Memorial Award, which Carbajal received in 2003.

“He was so hard on us about how we did business, yet he understood what we were trying to
achieve,” Carbajal says. Other credit unions also praised NCUA and state regulators for linking
them to information and resources that improve their ability to serve low-income and
underserved populations.

Expect Higher Expenses
Expenses will be higher in serving low-income members for a number of reasons. First, low-
income members make many small transactions and prefer face-to-face services. West Texas
Credit Union has 11,000 members, but deals with 28,000 to 32,000 member interactions in its
four branches every month because many members visit a branch two to three times a month.
The $40 million credit union has 42 employees.

“You need to commit to it and know you‟re going to be a labor intensive credit union,” Carbajal
says. While income from fees and interest will be higher, Carbajal cautions that costs will also

“When you serve this type of low-income membership, delinquency is going to be higher,
chargeoffs are going to be higher, but net return on assets is also going to be higher, because you
are pricing loans accordingly, and your interest income will be higher when you take a higher
risk on some of those loans,” Carbajal says. “Yes, you‟re going to make a little more money, but
you‟re going to need it to pay for those losses. Once you understand the process, you can live
with it.”

West Texas has learned to accept a delinquency rate of about 2 to 3 percent. If it gets below 1
percent, Carbajal says, “We‟re not making the right loans.”

Work With Other Credit Unions and Credit Union Organizations
One way to share the risk is to work with other credit unions, often by forming a Credit Union
Service Organization (CUSO). West Texas Credit Union is one of eight credit unions that joined
together to form El Paso Affordable Housing, which makes loans to help low-income residents
purchase their first home.

Under state laws, CUSOs are usually allowed to charge higher interest rates than credit unions.
Interest rate restrictions often make it difficult for credit unions to make small loans without
losing money due to combined restrictions on interest rates and fees. The ability to charge higher
rates allows a CUSO-based service to recoup the costs of making “payday” or “micro” loans of
$200 or less, while still charging far less for these loans than typical payday lenders.

Large credit unions and credit union organizations also help support low-income initiatives in a
number of ways. Seventeen credit unions nationwide provided capital for the establishment of
TULIP Cooperative Credit Union in Olympia, WA, by making nonmember deposits of $1.9
million in CDs that will earn below-market rates. TULIP also received grants from the National
Credit Union Foundation.

Other forms of support from credit unions in the Olympia area include creating a shared position
for the TULIP General Manager, who works 25 hours a week for TULIP and 15 hours a week
for Washington State Employees Credit Union, also in Olympia. Senior executives from O Bee
Credit Union in Tumwater, WA, also share their expertise by serving on TULIP committees.

Organizations Offers Assistance                     Launching a New Credit Union
Organizations like the National Federation of       Creating a new credit union seems like an obvious
                                                    way to solve the problem of bringing credit union
Community Development Credit Unions                 services to an underserved neighborhood. Yet
(NFCDCU) and the National Credit Union              starting a new credit union is a length and
Foundation (NCUF) can provide invaluable            cumbersome process, according to Mike Dunn,
funding and technical assistance to credit unions   chairman of the board at the new TULIP Cooperative
that serve low-income and underserved               Credit Union. Dunn is also the director of marketing
communities.                                        research at BECU, formerly known as Boeing
                                                    Employees’ Credit Union.
NFCDCU‟s Capitalization Program provides            Dunn and other volunteers worked for four years to
deposits to community development credit            prepare for the TULIP launch. Capital needs and
unions (CDCUs) so they can expand their             regulatory requirements were major barriers.
lending. Since 1996, the federation has helped      “BECU, one of the largest credit unions in the world
CDCUs strengthen their capital position through with $4.5 billion in assets, started with $9 in deposits
                                                    in 1935,” Dunn says. “A low-income credit union like
primary equity in the form of capital grants to
                                                    TULIP needed $2 million in non-member deposits and
credit unions, and secondary capital, which is      $250,000 in capital just to get the doors open. So
subordinated debt that functions as net worth for obviously the issue is sustainability. We are
purposes of prompt corrective action (PCA).         continually looking for grant money to replace money
The federation also offers special deposits that    going out the door, and it is a very difficult task.”
help share a portion of the risk when CDCUs         Dunn believes that regulators and the credit union
engage in high-impact and high-risk lending.        movement need to find a way to simply the process of
For example, Rosenthal says the federation also     establishing a new credit union, “because there’s a
makes Predatory Relief and Intervention             market out there and people out there who need
Deposits through its PRIDE program for             these services at an affordable rate.”
CDCUs, which allow participating credit unions
to make loans to victims or potential victims of payday lending, tax refund anticipation loans,
abusive mortgage loans, and other high-cost credit schemes.

NCUF gives grants to credit unions and related organizations for innovative development
initiatives. Grant funds have supported financial literacy, minority outreach, bankruptcy
education, and cooperative development. NCUF also funds research studies aimed at helping
credit unions meet the needs of diverse members. NCUF provided two grants to help establish
TULIP Cooperative Credit Union in Olympia, WA. A $5,000 grant from the Development
Educator Special Fund helped foster support and education as the proposal for the credit union
was developed. The foundation later committed $25,000 to help the fledgling credit union
purchase a data processing system.

        Serving Low-Income and Underserved Communities
The intent to help is rarely enough to successfully develop low-income lending programs. To
reach the target population, credit unions must learn more about what they need and then develop
programs that draw them into the credit union. People in low-income and underserved
communities may distrust financial institutions due to poor past experiences. They may need
education about how participating in a credit union can improve their lives. They may also lack

the information necessary to understand how their borrowing habits are hurting their financial
health. Credit unions must address all these issues to provide successful low-income lending

Learn to Talk to the Target Audience
Programs aimed at serving low-income and underserved individuals often have unique twists
because they serve unique populations. While products may be similar in many ways, they often
differ in the details of how they are structured and delivered. To design the right products for the
right audience it is essential to understand the needs of the particular community that will be

If you‟re serving an immigrant population, for example, the obstacles you face may be different
than serving an inner-city neighborhood. Carbajal says about 70 percent or more of residents in
the West Texas Credit Union service area are Hispanic, with about one-third representing first-
generation immigrants from Mexico.

“What we have found is very essential in serving these individuals is education,” Carbajal says.
“The mentality they have, coming from Mexico, is that you can‟t trust a bank.” The credit union
takes a step-by-step approach to teaching these members about a credit union and its services.
This extends to every facet of operations. For example, adding drive-through lanes to a branch in
an underserved area created the need to convince members that their money would travel safely
to and from the credit union, without getting lost irretrievably in the tube.

A number of questions can help credit unions learn more about low-income and underserved
    What is the income of prospective members?
    Where are they obtaining services now?
    How do our services compare to those of existing providers? Include factors such as how
     quickly loan funds are distributed, accessibility, and the atmosphere of the lender‟s office.
    What needs do they have that we could address?
    Do prospective members speak English, or will we need to provide bilingual employees
     and materials?
    What common practices do we use under the assumption that “everyone” understands
    How do we educate members about products without being patronizing or condescending?
    What types of lending products meet their needs?
    What community groups have credibility in the low-income or underserved community?
    What alternatives measures can I use to determine their ability to repay the loan? The
     ability to consistently pay rent can indicate whether a member can meet mortgage
     payments, for example.

                                                      Direct Deposit Still Applies
Credit unions are often surprised to learn that
users of predatory lending services such as           Direct deposit of payroll and benefit checks can play
                                                      a vital role in helping credit unions combat
payday lenders include a high number of credit
                                                      predatory lenders.
union members, including some who are
relatively affluent. Mazuma Credit Union, Kansas      ”That seems to be really fundamental,” Rosenthal
                                                      says. “It’s something that many credit unions try to
City, MO, conducted focus groups with 29 users        encourage, but it’s particularly important in lending
of payday lenders. It discovered that eight people    programs where people are vulnerable to these
in the focus groups were already credit union         quick-cash programs that are being promoted
members. Another indicator of the relative            around the country.”
affluence of some members using payday lenders        Direct deposit benefits low-income members by
is the creation of Internet-based payday lending      creating the basis for a regular relationship with the
services. Clearly, the individuals using these        credit union. This introduces them to low-cost
payday-lending services have regular access to a      options for obtaining cash, paying bills, and other
computer.                                             basic services. It also keeps them out of check
                                                      cashing “stores” where they are exposed to payday
                                                      lending and other predatory services.
Yet it is also important to serve low-income
members where they live. Transportation is
already a problem for many low-income members, who lack the time or the resources required to
travel outside their neighborhoods for financial services.

Plan to Serve Diverse Populations
As the U.S. continues to become diverse, the ability to attract first- and second-generation
immigrant families will become more important. The U.S. Census Bureau issued projections in
March 2004 showing that the country‟s Asian and Hispanic populations will triple in size by
mid-century. Hispanics are particularly targeted for growth, with the Hispanic population
expected to equal one-quarter of the overall U.S. population by 2050, spurred in part by higher-
than-expected immigration rates.

With diversity comes the requirement to understand cultural needs that influence lending. At
West Texas Credit Union, for example, Hispanic members who are recent arrivals from Mexico
often start building for the future by purchasing unimproved pieces of land known as “Colinas.”
These lots lack sewer, electricity, or water. Members borrow $500 to $1,000 to buy the lot and
start building their home one room at a time by themselves. Once the lot is paid for, they pay for
construction costs by borrowing small amounts of $1,000 to $2,000. Members may also borrow
$2,000 to $4,000 to purchase a mobile home so they can live on the lot while they build the
home. West Texas Credit Union meets their needs with unsecured signature loans.

Credit unions that seek to serve recent immigrants must also meet their needs for bilingual
communication. At West Texas Credit Union, bilingual services extend beyond bilingual front-
line employees to include options for Spanish-language versions of the newsletter, loan
applications, loan forms, and the voice response system.

Another essential service for recent immigrants is the ability to wire money back to family
members in their native country. Providers in low-income neighborhoods tend to charge high

fees for this service, sometimes as much as 28 percent of the transfer amount, while using
exchange rates that allow them to retain another chunk of the transfer. The International
Remittance Network (IRnet) offered by the World Council of Credit Unions allows members of
participating credit unions to send money home for as little as $10 per wire transfer, with
currency exchanged at the daily market rate. IRnet can also be used to transfer funds within the

Educate, Educate, Educate
Education is a vital part of any lending program aimed at low-income or underserved members.
Many low-income members lack basic knowledge about financial services. Tellers, member
service representatives (MSRs), and other front-line staff must be prepared to educate members
and refer them to the right loan products as part of everyday operations.

Credit unions often obtain grants or donations to support focused financial education activities.
Mazuma Credit Union is one of seven credit unions nationwide to obtain Housing and Urban
Development funds through the National Credit Union Foundation to providing housing
education. Mazuma plans to work with a neighborhood association to offer home equity loans
for members who complete financial education requirements. Mazuma has also used grant funds
from a community agency to create an education program called “Achievement in Money
Management” (AIMM). The AIMM financial educator visits nursing homes, community groups,
churches and other groups to talk about budgeting, credit repair, loans, and other topics. She also
meets with prospective members one-on-one to set up new accounts and provide financial
advice. Members who complete a basic AIMM class are set up on a savings plan of as little as $5
a month. If they meet their savings goals for three months, they qualify for a small loan.

The need to repair and maintain credit is another vital form of education for members. This can
often be handled one-on-one when meeting with loan officers or other credit union
representatives. Credit score enhancement education is used to help members save thousands of
dollars on loan interest by teaching them to improve credit scores by paying on time, maintaining
debt capacity, and using credit union products to improve their credit scores. Novartis Federal
Credit Union, East Hanover, NJ, sponsored a workshop on credit score enhancement for loan
officers and managers. It recruited other medium-sized credit union to help underwrite the cost
so small and low-income credit unions could afford to participate. Novartis President/CEO Ann
M. South worked personally with one member for more than a year to help move his score from
an “E” to a “B” rating. As a result, the member is saving $13,000 on mortgage interest annually.
Lending Solutions Consulting, Inc., provided Elgin, IL Novartis‟ score enhancement training.

Even the process of applying for a loan can be an educational opportunity. TULIP Cooperative
Credit Union works with many members who have limited incomes. Its lending criteria says that
members can have a maximum debt ratio of 50 percent, but Dunn says the credit union has
discovered that the real issue is whether members “have enough money in their month to make
the payment.” So everyone who applies for a loan must also fill out a basic monthly budget,
which helps the credit union educate members about how to manage their finances.

All members who join TULIP must attend a one-hour financial literacy orientation that teaches
them how to write a check and keep a check register. They also learn about their credit rating.
Meals and day care are provided for participants.

Create Community Partnerships
Credit unions that create new branches to serve low-income or underserved neighborhoods
should be prepared to encounter distrust and suspicion. This is a natural reaction considering that
residents‟ previous experiences have taught them that providers of financial services will seek to
take advantage of them. Community partners can help credit unions overcome this distrust to
gain credibility in low-income neighborhoods. Potential partners include churches and not-for-
profit organizations that are active in the community. Credit unions often report that they connect
with potential partners when taking part in community projects. Often, these community groups
seem to have watched the credit union‟s representative for weeks or months, weighing words and
actions to see whether the credit union is truly a trustworthy partner.

TULIP Cooperative Credit Union was created through a grass-roots effort that originated in a
community organization. TULIP stands for the Thurston Union of Low-Income People. The new
credit union opened its doors in December 2003. It is located within the Olympia Food Coop, a
natural foods cooperative that paid the salary of the credit union‟s coordinator for two years
before operations began. Working with another cooperative organization gave TULIP credibility
and created pent-up demand for services, so community residents began joining as soon as the
credit union was open for business, according to Mike Dunn, chairman of the TULIP board.
Dunn is also the director of marketing research at BECU, Tukwila, WA. It also made it possible
for the credit union would be able to attract affluent members alongside low-income members,
since the cooperative‟s membership attracts people from a wide range of backgrounds who are
drawn together by an interest in purchasing natural foods.

“What made this effort so successful so far is that it was a grassroots effort,” Dunn says. “It
wasn‟t a credit union going in and saying to people, „You need our services.‟ It was a community
putting it together and saying „We must address this need.‟” Dunn notes that six of the seven
board members are from the low-income community that surrounds the cooperative.

TULIP also has another partnership with TULIP Community Assets (TCA), a separate entity that
was formed by the same group that organized the credit union. TCA provides the credit union‟s
financial education classes, but it also provides financial education for non-members within the
low-income neighborhood. The goal is to provide a broad range of financial education, which
will ultimately prepare all residents to become better credit union members. “We‟ll always be
seeking these partnerships,” Dunn says.

West Texas Credit Union works with La Mujer Obrera (The Woman Worker), an organization
that helps displaced garment workers, to provide financial education and Individual
Development Accounts (IDAs) for group members. IDAs combine education and savings, often
using grants or donations to make it possible to “match” deposits in participants‟ accounts.

Mazuma Credit Union is working with community organizations to create a program where the
community organization would vouch for loan applicants. Participating organizations would
receive a coupon or letter that they could give to qualifying individuals who need a loan.
Individuals would take the coupon to Mazuma, who would accept it as proof that the individual
is qualified to receive the unsecured signature loan. If the new member defaults on the loan,
Mazuma would turn to the community organization to apply “moral incentive” for repayment.

While a credit union can partner with community organizations, it should also retain its separate
identity. This practice protected Florida Central Credit Union when its community partner,
Tampa Hillsborough Action Plan (THAP), was investigated for improper handling of grant
funds. When THAP‟s legal woes derailed a planned storefront operation to counter payday
lenders, Florida Central was able to relocate those functions to two branches in low-income

Help Members Earn Better Rates
Many credit unions offer low-income or underserved members the opportunity to earn better
interest rates on loans. At Mazuma Credit Union, for example, any member who makes 12
consecutive on-time payments on a current car loan is entitled to refinance with the credit union
at a lower rate. President/CEO Rob Givens say this policy allows Mazuma to reach more “C”
and “D” loans. It also helps those members who were forced to take a used-car dealer‟s loan at
interest rates as high as 30 percent. By making 12 on-time payments, the member is
automatically qualified for a credit union loan, where the rate is more likely to start at 15 percent
and work its way downward as the member proves his or her ability to repay the loan.

Some credit unions will also counsel members about how to earn better rates, and then check
back with the member to see whether they have completed the necessary steps. In this scenario,
the credit union might issue the used car loan at 10 percent, but counsel the member about how
much they can save every month by taking the steps necessary to qualify for a 7 percent rate. Bill
Myers, President and CEO of Alternatives Federal Credit Union, Ithaca, NY, notes that with
risk-based pricing, the credit union can adjust the rate as members credit score improves.

“Members will say, „Oh, I can get the loan now, and if I do it right, I can get a lower rate later?‟”
Myers says. “ And we say, „Exactly!‟”

Move Members to the Next Stage
Alternatives Federal Credit Union has developed a four-step process called the Credit Path to
describe how residents of low-income and underserved communities can be drawn into the
mainstream of credit union membership. Alternatives is a community development financial
institution that has $45 million in assets and serves 7,200 members with 36 employees. Myers
describes the Credit Path as the continuum between poverty and self-sufficiency.

Transactors occupy the bottom level of the Career Path. Even when they have an account at a
financial institution, transactors are “unbanked” because of their financial habits. They live day-
to-day, moving from paycheck to paycheck and relying on services such as check cashing to
provide funds. Instead of worrying about how to put money away for retirement, they‟re
concerned about finding money to put food on the table on all seven days of the week.

Understanding the needs of transactors helps credit unions recognize the motives for many
financial practices that appear shortsighted to outsiders. For example, getting a tax refund
anticipation loan from a predatory lender seems unreasonable when the fee eats up $50 of a $200
tax return. But if that $150 lets a parent put food on the table until the next paycheck arrives, it
suddenly seems like a reasonable decision.

“We often call these „stupid decisions‟ when we look at them out of context,” Myers says. “But a
„good value‟ isn‟t the way to look at it for transactors.”

The most difficult challenge in serving transactors is simply getting them in the door so they will
consider using the credit union as an alternative to existing providers. Transactors may purchase
services such as check cashing, bill payment services, money transfers, and access to the
payment system. At this level, the credit union can recoup the cost of services by pricing these
functions as stand-alone services. While this requires charging more than traditional credit union
rates, it still saves money for the member.

“The key to serving them is being willing to charge what it costs,” Myers says. “Many credit
unions like to bundle services so they can give them away for free.” But part of that dynamic is
that individuals who are unable to cross the threshold to qualify for the bundle – for example, by
keeping a specified amount in a savings or checking account – are then effectively barred from
obtaining affordable services at the credit union. Credit unions often try to appeal to transactors
by offering them a cheaper checking account option. Those credit unions are missing the point,
Myers says. Instead, the credit union is more likely to attract these members with products like
stored-value cards. Some products may be priced below their cost to persuade Transactors to
participate, but the ultimate goal should always be creating a long-term relationship that provides
growth opportunities for the member and the credit union alike. The key is to design products
that get these prospective members in the door, and then give them financial education to move
them to the next stage.

That second stage is defined as the saver. This person is beginning to see the vision of a long-
term financial future and is willing to sacrifice to save for a goal. They are active participants in
financial education because they have hope for a financial future.

“Saving money carries a lot of hope,” Myers says. “It shows that this individual can take action
to move out of this situation, and that the world will support you in that effort.”

Savers face significant risks when they move into the next stage to become borrowers. In serving
Borrowers, the goal is to enable the member build a credit score without borrowing against his or
her future. To achieve this objective, Alternatives offers “productive” credit to borrowers.
“Productive” credit should help borrowers meet at least one of these four goals:

       1)   Build a credit platform for future borrowing
       2)   Reduce expenses
       3)   Increase income
       4)   Even out the flow of income.

Myers notes that many people in low-income or underserved neighborhoods “fall off the path” at
this point by turning to predatory lenders or engaging in borrowing that keeps them standing still.

If members become successful borrowers, they can move on to the final stage in the Credit Path:
the Asset Goal. At this level, borrowers use credit union loans to achieve home ownership,
education, business ownership, or even stock ownership and retirement plans.

Myers notes that all four stages are interwoven, with some members showing elements of
different levels at the same time. But the key for the credit union is determining whether their
low-income and underserved lending products keep members moving along the path, or whether
they merely support members as they continue to walk in place. With every member, Myers says
achieving the Asset Goal should always be the credit union‟s objective.

Credit unions that want to use the Career Path to help members will probably need to change
their fees for products and services. Myers suggests that credit unions look at a vertical pricing
model, instead of a horizontal model. Most credit unions use a horizontal model that bundles
products to benefit existing users. Instead, Alternatives uses a model that focuses on moving the
member vertically up through the Credit Path. That means the credit union accepts a loss on
some products at the bottom of the Credit Path, which it expects to make up when these
individuals achieve The Asset Goal. An example is the common practice of offering free
accounts to children with the hope of retaining their business as adults. By applying the same
model to low-income savings and lending products, credit unions will encourage vertical

Create the Right Products
The challenge for most credit unions is offering products that stay beneath the state limit on
credit union interest rates, typically set at 18 percent, yet meet the needs of members. In some
cases, that will mean that credit unions cannot afford the administrative costs and higher risks
associated with small loans that help counter payday lenders. These credit unions can use a
number of products to help fill the gap for low-income and underserved members.

Offer overdraft privileges
West Texas Credit Union helps members avoid payday lenders by covering share draft account
overdrafts of up to $200 for a fee of $15. Members recognize that paying the fee is less
expensive than borrowing funds from a payday lender. The program also protects members from
the cost of having checks returned to merchants. In some cases, the program may be linked to
direct deposit to ensure that there is a steady flow of money into the account to cover overdrafts,
which helps protect the credit union.

Make members aware of “courtesy services” and rates
It‟s important to tell prospective members that simply joining the credit union makes it possible
to cash checks for free, instead of paying a percentage of the check‟s value to a storefront
operation. Even credit union products that carry a fee, such as money orders, are typically
cheaper than the rates charged by check cashing outlets. To meet the full range of low-income
members‟ needs, credit unions must be aware that they may need to add some products to serve
members who are still learning about basic financial services.

Develop options for unsecured signature loans
Members in low-income neighborhoods need loans for under $1,000 to fund a variety of needs,
from starting a home-based business to paying for medical emergencies. The first loan made
when TULIP Cooperative Credit Union opened its doors was an unsecured signature loan of
$1,000 to provide the first month‟s rent and the security deposit so a family of three could obtain
an apartment. The mother in this single-parent family has a job, but could not manage to
accumulate enough money to pay both rent and the security deposit. The family is making
regular payments on the loan. Other examples of signature loan programs are provided
throughout this white paper.

Create options for “new” borrowers to obtain used car loans
These borrowers may have obtained and repaid loans in the past by working with lenders outside
the traditional financial system, which means they lack a credit history. Again, the credit union
may need to educate members about the lower rates available from the credit union and the
importance of timely repayment. In some cases, credit union loan officers work with members to
create a step-by-step plan to qualify for a used car loan, perhaps by first successfully repaying a
small, unsecured signature loan.

Simplify paperwork
TULIP Cooperative Credit Union will keep loan applications on file for five years. That way
members who resolve a particular financial issue that prevented them from getting a loan can
simply return and report the change, without needing to complete the entire application again.
Mazuma Credit Union is using online applications to streamline micro-lending applications,
which will benefit repeat borrowers. The goal is to make obtaining a loan from the credit union
less intimidating for members who may have little experience with the financial system and
limited financial literacy.

Counter tax anticipation loans
Alternatives Federal Credit Union partnered with Volunteers In Tax Assistance (VITA) to come
up with an innovative alternative to tax anticipation loans and get prospective members in the
door. The free service was offered to community residents with incomes of less than $40,000.
Fifty volunteers helped more than 500 residents complete tax returns for free, which compares to
a cost of $75 to $100 from paid tax preparers. Alternatives provided marketing materials, the site
for the program, and committed one paid staff member to counsel every participant. The
counseling included encouraging participants to use at least a portion of the return to establish a
savings account. Participants also gained information about direct deposit and improving
financial practices. “The real trick in all this was getting people in the door,” Myers says. “A free
tax return is clearly a good deal. It brands us. It means a couple of thousand dollars for some

participants, so it‟s really a serious gift.” As an incentive for opening an account, it‟s also far
more meaningful to low-income residents than typical incentives, like a toaster.

Address the Payday Lender Problem
The frustration that credit union lenders feel when they watch members walk up to a payday loan
storefront or another provider of predatory loan products could be compared to the greengrocer
who watches people bypass his sidewalk display of broccoli to stand in line for ice cream. You
know that broccoli costs less and is better for your members, yet they‟ll pick ice cream every

The problem for many credit unions is that the products they offer to low-income and
underserved members are as appetizing as an endless diet of broccoli. The credit union‟s
products may be wholesome and good for the members‟ financial health, yet they lack the appeal
of payday lenders. That appeal includes a cheerful atmosphere, employees who greet customers
by name and get to know them as individuals, a sympathetic atmosphere that avoids judging
members, and a quick-and-easy application process that allows the borrower to quickly receive

The number of payday lenders nationwide has grown from roughly 200 lenders in the early
1990s to more than 10,000 in mid-2001, according to a Filene Research Institute study, The
Economics of Payday Lending. The Filene study
also revealed that about half of all payday-lending Take Out a Payday Loan
consumers had household incomes between
                                                    If you want to know what payday loans are doing to
$25,000 and $50,000. They are also likely to be     members and community residents, you may need
younger than the overall adult population and are   to take out a payday loan. Mazuma Credit Union
more likely to have children. They borrow from      sent all its senior executives into the community to
payday lenders because they believe it is the best  obtain payday loans from some of the 24 payday
way to meet immediate needs for cash in amounts loan stores, pawnshops, title lenders, and other
of $100 to $500.                                    predatory lenders located within a five-mile radius of
                                                         its Midtown branch. Reading the paperwork that
                                                         came with their loans convinced the credit union’s
To combat these lenders, experts say credit unions       executives that Mazuma needed to find a way to
must offer services with the same level of               counter these lenders’ predatory practices.
attraction for members. It is essential to suppress
                                                         One startling feature of payday loans is their ability
the desire to scold members for poor financial           to “roll over” the original loan, which can lead to the
practices. Instead, aim to educate members, while        borrower owing two to three times the amount of the
at the same time offering products that provide a        original loan in a relatively short period of time. This
fairly priced alternative to payday loans and            creates a cycle that makes it almost impossible to
similar products.                                        get out of debt.

Pilot Offers Micro Loans As „Payday‟ Alternative
Mazuma Credit Union is engaged in a promising experiment to partner with a “payday lender
with a heart” to offer an alternative to standard payday loans. In the spring of 2004, Mazuma

began referring members who need “micro loans” to PersonalAdvance, an online lender who has
agreed to provide loans of $200 to $500 to members. PersonalAdvance, which has its
headquarters in Maynard, MA, is a Wisconsin corporation partly owned by Universal Savings
Banc Holdings, Inc.

The cost to the borrower is a flat fee of $25 per $200 borrowed. Loans are delivered to the
member via direct deposit into Mazuma accounts within 24 hours. Loan repayment is also
handled electronically through savings or checking account debits on a flexible repayment

Andrew B. Appleton, President/COO of PersonalAdvance, says he began approaching credit
unions more than a year ago with the idea of helping bridge the gap between underserved
markets and traditional lenders. Appleton learned about the high cost of payday lending during
his years in the U.S. Marine Corps, first as an enlisted Marine and later as a commissioned
officer. Payday lenders often target people serving in the military for loans. PersonalAdvance
offers special “micro lending” services for active military personnel and Department of Defense
employees at rates of $20 per $200 loaned. Appleton says serving credit union members will
allow PersonalAdvance to take its mission of affordable small loans to a wider market.

“We feel that because of their fields of membership,
credit unions are better able to keep in touch with these      Services Offered by High-Interest
markets,” Appleton says. “We believe this means credit         Lenders in Low-Income
unions are better positioned to think outside the box of       Neighborhoods
traditional solutions and begin to understand that
                                                               Check cashing
developing a relationship with a member will take more
than opening an account.”                                      Payday loans
                                                               Small or short-term consumer loans
Members must enroll in Mazuma‟s “Graduation                    Money orders or certified checks
Program” to qualify for a loan. Enrollment involves            Wiring of funds, often to other countries by
paying a $20 fee and completing a 20-minute one-on-one         recent immigrants
financial counseling session. The fee is subtracted from       Postage stamps, transit tickets, and lottery
the member‟s first loan. To apply for the loan, members        tickets
visit the Mazuma web site and click on          Prepaid telephone cards
a link to PersonalAdvance to complete an online                Fax and photocopying services
application, which can be done either in their own homes       Utility bill payments, including prepaid cards
or by using computers located in any of Mazuma‟s seven         for utility services
branch offices. Once members successfully repay five           Loans on “pawned” personal possessions
PersonalAdvance loans, they qualify for a “New                 Car title loans
Borrower‟s Visa” with credit limits between $300 and           Mortgages
$1,500.                                                        Tax anticipation loans

The Mazuma program is an experiment for both the              Source: Fair Deal,  CUNA, 2000

credit union and PersonalAdvance. If the program proves
successful, Appleton hopes to expand it to credit unions nationwide.

Givens says Mazuma is pursuing the program because it makes it possible to directly compete
with payday lenders with small loans that are affordable for both the member and the credit

“If you want to make these kinds of loans, you have to make them instantly,” Givens says. “You
can‟t pull a credit check because most people won‟t pass and there isn‟t enough margin to cover
the cost. You can‟t say „No, you don‟t qualify,‟ because the program will dry up. These are not
people who will come in for a second dose of abuse, because that‟s not what they get from a
payday lender. The payday lender smiles and says, „Here‟s your loan,‟ so we have to replicate
that model.”

Credit unions interested in serving low-income and underserved members might want to get a
fresh dose of perspective from Alternatives Federal Credit Union. At Alternatives FCU,
underserved markets are viewed as marketing opportunities. The member who rents their home
is a potential first-time homeowner. Younger members are good targets for student loans.
Members in a low-income neighborhood are an opportunity to cultivate loyal relationships by
being their first trustworthy provider of financial services. And members accustomed to relying
on high-cost services will be difficult to disappoint with credit union‟s better rates and products.
But unlike other marketing opportunities, serving the underserved is rarely competitive.

“You‟re not likely to lose these members to someone else, because no one else is trying to serve
them,” Myers says wryly. When credit unions fail to serve these members, other lenders move
in. “Into that breech where banks don‟t go and credit unions don‟t go, predatory lenders have

Credit unions who are working hard to develop new approaches to lending to low-income and
underserved members seem to share this focus on opportunity, rather than obligation. They see
their service to low-income populations as an opportunity to strengthen the community by
strengthening the people who live and work there. With time and access to financial services and
education, they believe these low-income borrowers will become loyal members capable of
contributing to the credit union‟s long-term well-being. For everyone involved, that‟s a way to
do well by doing good.

About the Author
Darla Dernovsek specializes in writing about financial services, marketing, and technology. Her
published work includes numerous books, white papers, and articles written for the Credit Union
National Association. Dernovsek has also worked as a marketing executive in the healthcare and
electronic funds transfer (EFT) industries and as a newspaper reporter and editor. She is based in
Clinton, Wisconsin.

NCUA Office of Credit Union Development,
National Credit Union Foundation,
National Federation of Community Development Credit Unions
World Council of Credit Unions International Remittance Network (IRnet),

CUNA wishes to thank the following individuals for their contributions to this white paper.

Andrew B. Appleton, president and COO
PersonalAdvance, Maynard, MA

Rufino Carbajal, Jr., president and CEO
West Texas Credit Union, El Paso, TX

Mike Dunn
Director of marketing research, BECU, Tukwila, WA
Chairman of the board, TULIP Cooperative Credit Union, Olympia, WA

Edward J. Gallagly, president and CEO
Florida Central Credit Union, Tampa, FL

Rob Givens, president/CEO
Mazuma Credit Union, Kansas City, MO

Bill Myers, president and CEO
Alternatives Federal Credit Union, Ithaca, NY

Cliff Rosenthal, executive director
National Federation of Community Development Credit Unions, New York, NY


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