The following illustration will explain how a chit works.
There is a new chit group that is commencing. The value of the chit is 500,000. This amount is known as the Chit Value. For the purpose of this illustration, we will consider the duration of the chit to be 50 months. This is known as term period for the chit group.
The Foreman or Chit Fund Company has to gather 50 people who are interested in investing in this chit group. These 50 persons are called Subscribers.
Once the chit group commences, the foreman has to register the chit with the registrar of chits. He has to pay 100% of the chit value as security. This amount can be withdrawn only after the said chit group closes and every subscriber is paid what is due to him or her. This regulation protects the interests of the subscriber to a certain extent.
The amount to be saved every month by the Subscriber is Chit value/No of person’s i.e. 500,000/50 = 10,000. This is also known as Monthly Subscription. It may be noted here that the number of persons investing in a chit and the duration of the chit is always the same. The maximum monthly contribution or Subscription Amount that a Subscriber will pay is 10,000.
The Subscriber does not always pay the entire Subscription amount every month. Let us find out how and why he does not have to pay the entire amount.
The maximum discount or maximum bid permitted ranges from 30%. For the purpose of this illustration we will assume that a Subscriber has bid 35% of the chit value. 30% of 500,000 is 1,50,000. This amount is known as Chit Discount.
The foreman charges 5% of chit value as commission. In this illustration, that would amount to 25,000. This is deducted from Chit Discount i.e. 1,50,000-25000=1,25,000. This amount is available for equal distribution among the subscribers.
In our example, 1,25,000 would be divided equally among 50 subscribers. Each subscriber would get a discount of 1,25,000/50 = 2500. This amount is known as Dividend.
In the following month, all subscribers would have to only pay 7,500 instead of 10,000. This is because they have earned a chit discount of 2500.
Depending upon the competition within the chit group the discount percent would vary. The least discount would be 5% which is the foreman’s commission. The bidding process will continue until the end of the chit period.
In this manner, the subscribers can borrow more than what they paid in the first half period of the chit term and save their money if they decide wait further into the chit period.