We take a look at the differences between Shariah-compliant and conventional loan products and what homebuyers should know when considering Islamic home loans.
Malaysia has always been at the forefront of Shariah-compliant financial products and is seeing a growth in Shariah or Islamic home loans. According to RAM Rating Services, Islamic banking expanded at a much faster pace (11%) than conventional loans (3.3%) in 2018. As of end-January 2019, Islamic financing comprised 32% of the overall loans.
However, there are many consumers who do not really understand how an Islamic home loan works or how it differs from conventional ones. In this article, we delve more into the topic by answering 5 questions aspiring homeowners might have:
1. What is Islamic home financing?
According to Maybank Islamic, Shariah (Islamic law) prohibits the element of interest (riba) inherent in a conventional loan.
For most Shariah-compliant home loans in Malaysia, which operates under Bai Bithamin Ajil (BBA) concept, you will co-own the property with your bank and you make monthly payments to buy back the bank’s share of the property. Once you have made the final payment, the property will be transferred over to you via a gift transfer, also known as Hibah.
There are several ways that a Shariah-compliant contract can be done to ensure that the income derived from the transaction is not unlawful (haram):
• A sale contract (BBA) where the bank sells a Shariah-compliant asset (including property and commodity) to a customer with payment made on cash terms or deferred payments via instalments.
• A partnership (Musyarakah) contract where the bank and the customer jointly acquire and own a property. The customer will make progressive payments to the bank until they acquire full ownership of the property.
• A leasing (Ijarah) contract where the bank, as the property owner, leases out a property to a customer who will pay rent or rental instalments on the property. The customer would then have the option to buy off the property at the end of the leasing contract.
2. How does an Islamic home loan differ from conventional home loans?
|The bank acts as the lender and the customer as a borrower||1. Sales contract: Bank as seller, the customer as buyer
2. Partnership contract: Bank and customer as partners
3. Leasing contract: Bank as lessor, the customer as lessee
|The bank will charge interest for lending money. The interest computation is compounding and the accruing effect is unrestricted.||Bank’s profit is made via financing based on Shariah-compliant contracts. here is no compounding element of profit; instead, profit is computed based on the outstanding principal|
|Money is the subject matter of the transaction.||Money is the medium of exchange with the underlying asset as the subject matter of the transaction.|
Source: Maybank Islamic
3. What are the advantages of Islamic home financing?
This table should help both Muslim and non-Muslim homebuyers who are considering Islamic home loans as a financing option:
Conventional Home Financing
Islamic Home Financing
Interest/ Profit Rate Capping
|Interest is based on Base Rate which can be adjusted based on prevailing market conditions without any ceiling/capping.
In the event of an interest rate hike, the customer will have to pay a higher instalment amount to accommodate the increase in lending costs. Read what is Base Rate & how it affects your home loan.
|The ceiling profit rate is the maximum profit rate that can be charged under a sale based financing. Profit is based on the Islamic Base Rate (BFR) and can be adjusted based on prevailing market conditions but it cannot at any time exceed the ceiling profit rate.
Computation of Interest/Profit
|Interest is computed and charged based on compounding interest and Principal.
Effect of the accruing interest on the loan is limitless, which can eventually lead to oppression.
|– Profit is charged based on outstanding principal only with no compounding element involved.
– Due to the non-compounding nature, the total profit payable for the financing will be much lower as compared with conventional loans. This also means that late home loan payments might incur cheaper charges.
Exit Penalty/ Lock-in period for Early Settlement
|There is an exit penalty and lock-in period if the customer makes an early settlement.||The customer can exit anytime without a penalty. Based on the principle of fairness, the customer is encouraged to settle their obligations and not be penalised by an exit fee if they make an early settlement.|
Exemption of stamp duty for home loan refinancing
|No exemption||The customer enjoys a stamp duty waiver on the existing home loan’s balance when they convert their facility to an Islamic home loan.|
Source: Maybank Islamic
However, Islamic financing does have its drawbacks too. These include:
- Additional costs during loan restructuring: Should the borrower opt to modify their loan terms, they would have to fork out money for a new loan facility agreement.
- Legal costs might be higher than a conventional home loan as there are more documents involved for Islamic financing.
- Contractual terms including matters such as late settlements/defaults and early settlements may not be as transparent as those in a conventional home loan contract.
4. What are some of the things I should consider before taking up an Islamic home loan?
On that note, a savvy homebuyer should keep an eye out for the following:
If you are used to conventional home loans, the Islamic home loans have different documentations like the Sell and Buy Back Agreement that you might not be familiar with. Hiring an informed lawyer that can explain these things to you will be helpful. With the additional documentation required for Islamic home loans, the legal fees incurred could go up by about 10%. Also, the prior government initiative of 20% stamp duty waiver on Islamic home loans has been discontinued.
Late payment penalty
As Islamic home loans do not charge interest, penalties for late payment varies from one bank to another. It is important to find out how your bank charges it.
Most banks have no lock-in periods for Islamic home loans while some do. It is important to check with the bank if this matters to you.
Usage of property
Some product disclosure sheets state that the purchased property cannot be used for activities that are illegal, immoral or not Shariah-compliant. This will not pose a problem for residential homes but if the property is for commercial use (especially with SOHO units), it is best to check with your bank what activities are considered to not be Shariah-compliant.
5. What are the requirements and application process like for Islamic home loans?
The application process for an Islamic home loan is the same as a conventional one and the list of required documents include:
- NRIC / Identity Card
- Copy of Sales and Purchase or Booking Receipt or Letter of Offer from Developer
- Copy of Individual Title Deed
- Property Valuation Report (for completed properties)
- Latest 3 consecutive months of salary slips/vouchers
- Latest 6 consecutive months of commission statement
- Latest EPF statements (with 3 consecutive months or more transaction history)
- Latest EA form * Latest 6 months Bank Statement
- Letter of Confirmation of Employment and Remuneration
Anyone can take up an Islamic home loan, whether you are a Muslim or not. For Muslim homebuyers, taking an Islamic home loan means that they can be assured that there will be no element of interest. For non-Muslim homebuyers, this is an additional product available in the market that they can consider. Shariah-compliance aside, most loan agents will tell you that there is not much difference between the two in terms of interest rates and repayment.
As with any financial products, the key thing is to compare the various products available in the market and between different financial institutions. This will help ensure that you choose the right one based on your needs.
Edited by Reena Kaur Bhatt