A chit fund/ is both a savings and credit product. It bears a pre-determined value and is of a fixed duration, mostly two to three years. Each scheme admits a specific number of members whose monthly contributions adds up to the total value of the chit fund at the end of the term.
Here is a look at how a chit fund works.
A joins a chit fund worth Rs 60,000, at a monthly subscription fee of Rs 1,000, for 60 months. The scheme will have 60 participants contributing to the ‘pot’.
At the end of the month comes the auction. Any group member can bid for the pot (worth Rs 60,000 now).
A member can bid for the pot at par, minus the 5-7% foreman’s commission.
The person bidding with the ‘deepest cut’ (or discount) gets the pot. But at no point can the bid drop below 40% of the value of the pot.
Assume member A bids at Rs 1,000 discount while B and C stake claim at Rs 800 and Rs 600 respectively.
Being the bidder with ‘deepest cut’, A wins the pot. The foreman pays A Rs 59,000, after deducting Rs 1,000 (the discount) from the pot value. The Rs 1,000, deducted from A’s payout, is divided among other members of the group.
A has to continue paying his subscription fee of Rs 1,000 for the remaining months.
By calling money early, and at Rs 1,000 discount, A benefits from timely receipt of funds.
A will also get dividends if other members bid at heavier discounts for the pot in subsequent months.
Members who do not borrow from the ‘pot’ benefit from dividend accruals; they may earn 7-10% on their investments.
Higher the borrowings from the pot, higher the returns at term.
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