BUYING a home can be a thrilling experience. It also involves making one of the biggest investment decisions in your life. Having spent the time and effort to look for your dream property, shouldn't you also be as diligent when deciding on how to pay for it? After all, it can take many years before you finally pay off the loan you've taken for your home.
There are different types of home loans currently available for you to choose from. Comparing them based on the interest rate offered can be a good starting point, but you would also need to pay close attention to little details such as the fees and charges imposed before making your decision. What you want is a financing package that fits your needs, and having the peace of mind from knowing that you would be able to afford the repayments over the duration of the loan.
Be mindful however that taking out a loan places certain obligations on you as the borrower. Loans generally attract interest which, depending on the package, may fluctuate over the years. If interest rates go up, you may have to pay more. Late payments would also attract additional interest. As a borrower, you are obliged not only to repay the principal amount of the loan, but also all outstanding interest. As such, there is an element of uncertainty in how much you would end up paying.
The relationship between a lender and borrower is different under Islamic banking, as the concept of interest is alien in Islam and strictly prohibited. How then does Islamic financing differ from conventional loans? If you were to use Islamic financing to pay for your newly-purchased home, the relationship you would have with the bank is typically that of a buyer and seller.
In a buyer-seller transaction, you pay an agreed price, with the seller expected to make some profit from the sale. That is the basis of any trading activity in the world.
Applied to Islamic home financing, this means that the bank will first buy the house of your dreams and then sell it to you at an agreed price which will include the bank's profit. Will an Islamic bank's profit rate be about as much as the interest charged by conventional banks? Most probably, because Islamic banks are basically running a business and competing directly with conventional banks for customers. However, because the profit has been fixed in advance, the general principle is that you as an Islamic banking customer should not end up paying more than the agreed purchase price.
Sounds similar to a fixed-interest rate loan, you may say. Yes and no, as there is one key difference. Under conventional loans, penalties for late payment and arrears continue to attract interest for as long as they are still outstanding. So, you could be paying interest on interest, which are compounding. Compare this to Islamic financing, where late payments and arrears also incur penalties, but at a fixed rate and are not compounded. The reason being that Islamic banks are only allowed to charge the additional administrative costs they had incurred in trying to obtain the payment in arrears. This wouldn't make any difference though, if you diligently keep to your repayment schedule.
Home financing repayments usually spread over many years so that the monthly installments can be affordable. Under Islamic banking, this concept of deferred payment sale with agreed profit is known as Bai' Bithaman Ajil. Don't let the arabic name distract you. Islamic financing may have originated from the Middle East, but it is not meant only for Muslims. All you need to know is that Islamic banking is premised on an equitable relationship between the bank and its customers as defined by Islamic laws, or shariah. Every Islamic financial institution will have a governing shariah council comprising of independent Islamic scholars and legal experts overseeing its activities to ensure strict compliance.
Is Islamic financing for you? Certainly it gives you an additional choice when deciding on a home financing package that would meet your needs. At the end of the day, it is whatever that suits you best, and the only way to find out is to give attention to the details of the different packages that you are considering, and not just basing your decision on the interest or profit rates being offered.
Common Shariah terms
Mudharabah (profit-sharing)
An arrangement or agreement between a capital provider and an entrepreneur, whereby the entrepreneur can mobilise funds for its business activity. Any profits made will be shared between the two according to an agreed ratio while losses are borne solely by the capital provider.
Murabahah (cost-plus)
The selling of goods at a price, which includes a profit margin agreed by both parties. The purchase and selling price, profit margin and all other costs must be clearly stated at the time of the sale agreement.
Wadiah (safekeeping)
Similiar to a conventional savings account, Wadiah allows the safekeeping of deposits in the bank with guaranteed refund when the depositor demands for it. The depositor, at the bank's discretion, may be rewarded with `hibah' (gift) as a form of appreciation for the use of funds by the bank.
Musyarakah (joint-venture)
Applied usually for business partnerships, profits made on the basis of Musyarakah are shared on an agreed ratio while losses will be divided based on the equity participation ratio.
Bai' Bithaman Ajil (deferred payment sale)
The selling of goods on a deferred payment basis at a price which includes a profit margin agreed by both parties.
Wakalah (agency)
When a person appoints a representative to undertake transactions on his/her behalf.
Ijarah Thumma Al Bai' (hire purchase)
Divided into two contracts, the Ijarah contract is the first of two contracts under this agreement whereby the customer leases the car from the owner (bank) at an agreed rental over a specific period. The second contract, Bai' enables the customer to purchase the car at an agreed price after the leasing period ends.
Bai' al-Inah (sale and buyback agreement)
The financier sells an asset to the customer on deferred payment and then the asset is immediately repurchased by the financier for cash at a discount.
Source: Bank Negara website
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