What is Chit Fund and How It Works? – Types and Benefits

If you are looking to invest or park your money somewhere, you must have come across this term called chit fund. This is quite popular in south Asian countries like India, Pakistan, Bangladesh, and some other Asian countries. So, if you are interested in knowing what a chit fund is and how It works you are at the right place.

What is Chit Fund?

A chit fund is a financial instrument that acts both as a credit and savings product. Chit funds are offered by financial institutions like banks. There are some chit funds that are offered not by financial institutions, but by normal people like your friends or families. All these chit funds come with some clauses which have to be adhered to by all the investors. The investment value is pre-determined along with the time period and all people participating in it have to abide by it.

How Does Chit Fund Work?

Now that you understand what a chit fund is, it’s time you understand how it works. The working of a chit fund is very simple. So, let’s understand this with the help of an example.

Say 12 people together decide to start a chit fund with an investment amount of ₹1,000 each month for 12 months. At the end of the month, all the investors gather and bid for the entire collected amount for the month.

In this case, the total collected is ₹12,000. So, anyone can bid for this amount at a discount. However, the discount percentage cannot be less than 40% of the total collected value. Suppose, the winning bid is at ₹10,000, then the person who bid the amount takes it and the remaining ₹2,000 is divided amongst the remaining members after subtracting the organizers fee which is between 5% to 7%.

This is repeated every month till the duration of the fund. The person who has won the bid earlier cannot bid again but has to contribute the fixed amount agreed upon at the beginning till the duration of the chit fund.

Types of Chit Funds

There 5 types of chit funds on offer these days. They are:

1. Registered Chit Funds

These types of chit funds are registered with the registrar of firms societies and Chits. This type of chit fund is regulated by the RBI which is the regulatory body for a financial institution in India. These funds are regulated by the Chit Funds Act of 1982 and is enforced across all states in India.

2. Unregistered Chit Funds

As the name suggests, these chit funds are not registered under the Chit Funds Act of 1982. These types of chit funds are mostly operated by individuals who aren’t professionals but may be related to you personally. Since it is not registered and no governing body overlooking it, investing in this type of fund can be risky.

3. Online Digital Chit Funds

When everything is going digital, why should investment techniques be left behind? These types of funds are online and all investments and auctions happen online. The monthly payment is also done online mode. For this, each investor has to create an online account to manage.

4. Organized Chit Funds

In this type of fund, all the participating members meet together on a predetermined date and place. Here, the names of all members are written on a piece of paper and then drawn randomly. The person whose name comes gets the entire collection of the fund. In the next meeting although, the previously selected name will not be taken but the person has to be present for the meeting.

5. Special Purpose Chit Funds

This type of chit fund is created for a special purpose and is to be utilized for that purpose only. For example, a chit fund is created for the construction of roads in the village. Then all members contribute equally and when the desired amount is reached, it is used for the construction of the road only. This helps reduce costs and efforts for all its contributors.

Benefits of Chit Fund

A chit fund offers the following benefits to its investors:

  • Quick access to money: If you are in sudden need of a large amount of money, then you can do it with the help of a chit fund.
  • No collateral required: There is no need of putting in a collateral in order to invest in a chit fund.
  • Flexible use: Unless it’s a special purpose chit fund, you can utilize the money for any purpose you want to – be it a wedding, loan payment or any other thing.
  • Low interest: If anyone wants to borrow from the fund, he or she can do so at a low interest rate.
  • Saving and investment: This type of fund offers the investor both a saving and borrowing option as and when needed by the investor.

To Sum it Up

Chit funds are a good tool and offer a lot of flexibility to the investors. It can be useful if you require a large sum of money in a short period of time. However, they do come with risks due to lack of paperwork requirements and one should be cautious before investing in them. Investing through a registered chit fund should be your safest option.

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