HomeInvestmentWhat are Chit Funds? How do Chit Funds Work?

What are Chit Funds? How do Chit Funds Work?

A Chit Funds are famous saving schemes in India. A Chit funds brings savers and borrowers on the same platform. A Chit Funds are good for saving money, however, we keep on hearing news about cheating via chit funds. So, in this post let’s try to demystify what are Chit Funds? How do Chit Funds Work? What precaution should you take while investing in Chit Funds?

What are Chit Funds?

A Chit Fund is all in one financial instrument. A definition of chit fund varies from person to person. For one set of people, it is a money deposit scheme, a saving cum investment scheme. For another set of people, it is a loan or credit scheme.

In short chit funds are saving cum borrowing schemes, where member or subscriber agrees to contribute fixed amount every month for the fixed period. The total amount contributed by subscribers shall be auctioned and given as prize money to needy subscriber every month.

An exact analogy of chit fund is kitty party. In kitty party, the party is arranged every month at different subscriber place. Similar to kitty party in chit fund specified amount is contributed every month by the subscriber and one subscriber gets entire fund. The process is carried out every month till all subscriber of chit fund gets a chance to avail booty. In kitty party, lucky draw takes place here auction takes place for the subscribers.

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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 type 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 these type of chit funds.
  • Private Register Chit Funds – There are a number of privately held register chit funds. These funds are registered as per Chit Funds act 1982.
  • Unregistered chit – It is illegal to run 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?

Once chit fund begins it has to register itself with the authority and submit 100% amount of chit as security amount. Suppose one chit fund start with 50 members with a monthly contribution of Rs.10,000 per month.

50 people x Rs 10,000 = 5 Lakh

The amount collected from all member in a group called as pot.

Once this amount is collected it is placed for the auction among subscribers. The subscriber who agrees to take the lowest amount will get the prize (pot amount). Suppose for the first month one subscriber bid lowest say 65% of pot amount. This means 3.25 Lakh (65% of pot amount) will be given to this subscriber as a prize.

5 Lakh – 3.25 Lakh = 1.75 Lakh (Remaining amount)

Suppose 5% commission is charged by Foreman. Foreman is a person or company who started chit fund.

5% of 5 Lakh (Total Pot amount) = Rs 25,000

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The remaining amount will be 1.5 Lac. This amount will be distributed among other subscribers. All remaining subscribers get Rs.3000 each. So, effective contribution for the first month would be Rs 7000 for every subscriber.  The process of auction will continue every month till all subscriber get the pot at least once. In next month auction only non-prize subscribers can participate as a bidder.

how chit funds work

Advantage of Chit Funds

  • Chit fund gives the flexibility to borrow and save.
  • You can get a chance to borrow money (pot) just by paying first monthly installment.
  • Best for needy people. You can get finance without any documents like IT returns, PAN card etc.
  • The non-prized subscriber who is a saving member up to the last installments gets a dividend which is comparatively higher than the interest that are accrued by way of other Deposit Schemes.
  • You need not disclose for which purpose you will be using the prize money.

Disadvantage of Chit Funds

  • No guarantee of fix returns.
  • Chance of fraud is high suppose foreman run away with corpus amount.
  • A winning subscriber may disappear after winning the first bid.
  • The subscriber may default and not ready to pay next installments.
  • High degree of risk with very little protection.

What precaution should you take while investing in Chit Funds?

As chit fund is a risky investment you should take following precautions before investing in a chit fund.

  • A chit fund should be registered. Check the certificate of incorporation from the registrar or the companies.
  • Check the certificate and registration number issued by registrar of chit funds of state in which the chit operates.
  • Check details about promoters before investing in chit. The promoters of chit should be financially sound.
  • You should be ready to contribute throughout chit fund cycle.
  • Verify from the office of the registrar of chit funds whether any complaint or court case pending against the chit company.
  • Check foreman commission. Go for chit with lowest commission.

Your Rights as a Chit Fund Subscriber

As a subscriber of chit you have following rights.

  • The rights to get proper receipt and copy of chit agreement for the payment subscription.
  • The right to get the amount after the chit is prized in your favor.
  • The right to attend auction and bid during acution.
  • The right to enter in to arbitration in case of disputes.
  • The right to inspect the chit records as a subscriber.

Should you save money via Chit Funds?

As per me this option is not advisable for the average investor. The effective rate of interest on borrowing under chit is very high and it is as good as personal loan. The interest offered by chit on the savings seems to be high but average return depends upon auction bid. You should select chit fund only if you have bad credit history and you are unable to get loan from the bank.

Another reason to select chit is excessive black money. The unregister chit fund is a place to park your unaccounted money. As most of the transaction take place in cash. You might have seen shopkeepers giving small chit amount of Rs.100-200 on daily basis that is chit fund.

If you are planning to invest in chit fund as a saving option big NO from my side. I will advise to go for bank fixed deposit or PPF which will fetch you secure return.

What are your thoughts about chit fund? Do share your views in comment section.

Shitanshu Kapadia
Shitanshu Kapadia
Hi, I am Shitanshu founder of moneyexcel.com. I am engaged in blogging & Digital Marketing for 10 years. The purpose of this blog is to share my experience, knowledge and help people in managing money. Please note that the views expressed on this Blog are clarifications meant for reference and guidance of the readers to explore further on the topics. These should not be construed as investment , tax, financial advice or legal opinion. Please consult a qualified financial planner and do your own due diligence before making any investment decision.
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