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How a chit fund works?

A chit scheme generally has a pre-determined value and duration. Each scheme admits a particular number of members (generally equal to the duration of the scheme), who contribute a certain sum of money every month (or everyday) to the 'pot'. The 'pot' is then auctioned out every month. The person bidding the lowest sum gets the bid amount.


The working mode is simple. Businessman 'A' joins a . 50,000-worth chit fund, with a monthly subscription fees of . 1,000 for 50 months. There are 50 members contributing to the 'pot'. In the first month itself, when all the 50 members contribute . 1,000, the the 'pot' becomes worth . 50,000. As per chit laws, 'A' has the right to bid for the 'pot' (which collects a monthly subscription of . 50,000 every month). In most cases, 'A' can bid almost the full value of the pot. When there are multiple bidders, the person bidding the lowest amount (than the 'pot' value) gets the money. Even if 'A' has bid money from the 'pot' at a discount (say . 49000), he has to continue paying his subscription fees of . 1,000 till tenure.
If one takes the simplest of calculations, 'A' pays in . 50,000 at the end of 50 months, but he gets only . 49,000. However, 'A' benefits from the timely receipt of funds; he also gets dividends (which will reduce his . 1,000 shortfall to pot) if other members have borrowed from the 'pot' in subsequent months. The . 1,000 that 'A' pays in divided among other members of the chit fund, which is their profit or dividend. Members who have not borrowed from the 'pot' generally make 10-12% returns on their investments.


Even if the member bids in the early life-period of the chit fund – say 2-3 months into the first subscription, the cost of money borrowed (the difference between pot and money bid by the member) will be around 12- 14%, much lower than 19%-plus rates charged by banks on unsecured loans.

 

 

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