Meaning of Chit Funds and How It Works?

Updated: Oct 10, 2018

Chit Funds are finance saving schemes in India. A Chit Funds are good for saving money. Chit Funds has both merits and demerits. One who haven't go for auction until last installment will be having a greater advantage of higher returns. Chit industry is more famous because it runs without any security being taken and runs mostly on trust.

Will see in detailed the whole cycle of chit industry....

Meaning of Chit Funds:

A Chit Fund is a financial instrument. Perception 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.The chit will be sanctioned to a person of lowest bid. 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 the total sum.

The entire chit fund process is monitored and managed by one person called "foreman" and he will take the fixed amount of commission every month from the members.

Types of Chit Funds in India:

There are three types of chit funds in India.

  • Chit Funds run by State Government.

  • Private Register Chit Funds registered as per Chit Funds act 1982.

  • Unregistered chit – It is illegal to run unregistered chit fund. These funds are usually run by a family relatives, friends, known persons etc.

How Chit Works?

Step by step guide...

Once chit fund begins it has to register itself with the authority and submit 100% amount of chit as security amount.

Example: One chit fund start with 10 members with a monthly contribution of Rs.10,000 per month.

10 people x Rs 10,000 = 1 lakh

The amount collected from all member in a group called as pot. Once the amount is collected it is placed for the auction among subscribers. The subscriber who agrees to take the lowest amount will get the prize. Suppose for the first month one subscriber bid lowest say 75% of pot amount. This means Rs.75,000/- (75% of pot amount) will be given to him as a prize.

Suppose 10% commission is charged by Foreman, total of Rs.10,000/- (1,00,000*10%) will be paid to him.

Remaining amount of Rs.15000/- (1,00,000 - 75,000 - 10,000) will be distributed among other subscribers. All remaining subscribers get Rs.1,500 each and it is called 'Rebate or discount received'. So, effective contribution for the first month would be Rs.8,500/-(10,000-1,500) for every subscriber. 

This process will continue every month till all subscriber get the pot at least once. In next month auction only the other non-prize subscribers can participate as a bidder.

Points to be remembered while investing in Chit Funds?

As chit fund is a risky investment you should keep in mind following points before investing in a chit fund.

  • Check the certificate of incorporation of chit fund 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.

  • Know about promoters. The promoters of chit should be financially sound.

  • Verify any pending suite against the chit funds from the office of the registrar of chit funds.

  • Check foreman commission. Go for chit with lowest commission.

Important Points:

1. This option is not advisable for the average investor.

2. The effective rate of interest on borrowing under chit is very high and it is as good as personal loan.

3. The interest offered by chit seems to be high but average return depends upon auction bid.

4. You should select chit fund only if you are unable to get loan from the bank.

Accounting treatment for Chit Funds (Click Here)

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