Ever stumbled upon the term “Chit Fund” and wondered what it really means? Well, you’re not alone. For decades, chit funds have quietly worked as the backbone of small savings and informal borrowing in India. They’re fascinating financial instruments that combine saving, borrowing, and community trust—all rolled into one.
But here’s the kicker: while many people have heard of chit funds, only a few actually understand how they work. Some even confuse them with shady schemes (and let’s be honest, a few scams have spoiled their reputation). Still, chit funds, when managed properly and legally, can be a lifeline for middle-class families, small businesses, and anyone who needs access to lump-sum money without jumping through the hoops of banks.
So, if you’re asking yourself, “What are chit funds? How do chit funds work?”—grab a cup of tea and read on. This guide will unpack everything in plain English, from the basics to the nitty-gritty, peppered with examples, pros, cons, and even FAQs.
What are Chit Funds?
A Chit Fund is an all-in-one financial instrument. A definition of a chit fund varies from person to person. For one set of people, it is a money deposit scheme, a savings cum investment scheme. For another set of people, it is a loan or credit scheme.
In short, chit funds are savings cum borrowing schemes, where a member or subscriber agrees to contribute a fixed amount every month for a fixed period. The total amount contributed by subscribers shall be auctioned and given as prize money to needy subscribers every month.
An exact analogy of a chit fund is a kitty party. In a kitty party, the party is arranged every month at a different subscriber’s place. Similar to a kitty party in a chit fund specified amount is contributed every month by the subscriber, and one subscriber gets the entire fund. The process is carried out every month till all subscribers of the chit fund get a chance to avail booty. At the kitty party, a lucky draw takes place here auction takes place for the subscribers.
At its core, a chit fund is both a savings tool and a credit system. Think of it as a group of people pooling their money together every month, and then each member gets a turn to take home the collective amount.
Sounds simple, right? Well, let’s break it down further.
A chit fund is a type of rotating savings and credit association.
It involves a group of people (called subscribers) contributing a fixed sum of money every month.
The pooled money is then given to one member of the group in a systematic way—usually through an auction or a draw.
In other words, chit funds are like a community piggy bank where everyone puts in money, but one person gets the benefit of taking out the lump sum each month.
Example of a Simple Chit Fund
Imagine you and nine friends start a chit fund:
Each person contributes ₹10,000 a month.
So, the total monthly collection = ₹1,00,000.
In the first month, one member gets the full ₹1,00,000.
Next month, another member gets it.
This continues until every person has received the lump sum once.
Of course, in real-world chit funds, auctions, discounts, and foreman commissions come into play. But more on that later.
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Types of Chit Funds in India
There are three types of chit funds in India.
- Chit Funds run by State Government – These types of chit funds are run by state governments. These types of chit fund are completely transparent. Kerala State Financial Enterprise and Mysore Sales International Limited are examples of this type of chit fund.
- Private Register Chit Funds – There are a number of privately held register chit funds. These funds are registered as per the Chit Funds Act 1982.
- Unregistered chit – It is illegal to run an unregistered chit fund. However, you will find many unregistered chit funds across the country. These funds are usually run by a closed group such as relatives, friends, neighbors, etc.
How Do Chit Funds Work?
Okay, now let’s get into the mechanics. How does a chit fund really operate?
The functioning of chit funds usually revolves around four key players:
The Foreman – The organizer who starts and manages the chit fund.
Subscribers – The members who join the fund and contribute regularly.
Chit Value – The total money collected each month (number of members × contribution).
Bid or Auction System – The process by which members decide who gets the money each month.
Step-by-Step Process of a Chit Fund
Let’s simplify the whole thing into steps:
Formation of the Group
A foreman gathers a group of subscribers. For example, 20 members agree to join a chit of ₹5,000 each per month.
Contribution
Every member pays their share monthly. Total = ₹1,00,000.
Auction or Bidding
Members bid for the pooled money.
Suppose one person agrees to take ₹80,000 instead of ₹1,00,000 (leaving behind ₹20,000 as a discount).
Distribution of Discount
The ₹20,000 is divided among all members as a dividend. So, everyone benefits.
Next Month, Repeat
Another member wins the auction the following month.
This cycle continues until all members get their turn.
Foreman’s Commission
The foreman takes a small cut (say 5%) for managing the chit.
Why Do People Join Chit Funds?
You might be wondering: “Why not just put the money in a bank?” Well, here’s why chit funds still attract millions:
Advantages of Chit Funds
Easy Access to Money: No need for collateral, unlike banks.
Dual Benefit: Acts as both savings and borrowing.
Community Trust: Works best among friends, family, or known groups.
Flexibility: Members can use funds for emergencies, weddings, education, or even business capital.
Better Returns (Sometimes): The dividends from others’ discounts can make chit funds more attractive than fixed deposits.
Risks and Challenges of Chit Funds
Of course, chit funds aren’t all rainbows and sunshine. They come with risks too.
Fraud & Mismanagement: Unscrupulous foremen or fake chit companies can vanish with the money.
No Guarantee of Returns: Unlike banks, chit funds aren’t insured.
Legal Issues: Many local chit funds operate illegally outside the Chit Funds Act.
Default Risk: If members don’t pay their monthly contributions, the entire system can collapse.
So, chit funds are best joined when you know and trust the group or company running them.
Chit Funds vs Banks – What’s the Difference?
A common question is whether chit funds are better than traditional banking products. Here’s a quick comparison:
| Feature | Chit Funds | Banks |
|---|---|---|
| Accessibility | Easy, community-based | Requires paperwork, credit check |
| Returns | Variable, depends on bids | Fixed (FD, RD rates) |
| Risk | Higher (default/fraud risk) | Low (insured, regulated) |
| Flexibility | High | Limited |
| Trust Factor | Depends on group/foreman | Institutional trust |
FAQs
1. What is the main purpose of a chit fund?
To provide both a savings avenue and easy access to lump-sum money without formal banking hurdles.
2. Are chit funds legal in India?
Yes, registered chit funds are legal under the Chit Funds Act, 1982.
3. Are chit funds safe?
They’re safe if registered and managed by reputed organizations, but risky if informal or unregulated.
4. Can chit funds replace banks?
No. Banks offer security and insured deposits, whereas chit funds are community-based and riskier.
5. Who usually benefits the most in a chit fund?
Early winners get quick access to lump sums.
Later winners enjoy dividends and sometimes higher returns.
Conclusion
So, let’s wrap this up. When someone asks, “What are chit funds? How do chit funds work?”—you now know the answer.
Chit funds are age-old financial tools that thrive on trust, discipline, and community participation. They act as both savings and borrowing platforms, making them incredibly useful for people who need flexibility and quick access to money.
But—and this is a big but—they come with risks. Fraud, mismanagement, and default can derail the system. That’s why joining a registered, trusted chit fund company is crucial.
At the end of the day, chit funds are neither saints nor villains. They’re just tools. And like any tool, their effectiveness depends on how wisely you use them.
