Islamic Home Loan Vs. Conventional Home Loan

Post : December 27, 2021

Islamic finance offers value to its customers through Sharia-compliant products, products integrated with Islamic laws. More significantly, zero tolerance for Interest. In Quran, the definition of Interest is "effortless profit" that gasps selfishness. Therefore, Islam has prohibited "extra money" by the means of interest for Muslims.

In contrast to Interest-based home loans, Islamic banks and other financial houses offer Islamic home loans. These loans come with greater flexibility and are economically viable for the customers. Under different product umbrellas like Ijarah, Diminishing Mushrakha and Murabaha, Islamic home loans follow strict Sharia laws.

When Islamic home loans offer the same schemes and packages, how does it becomes different from a conventional home loan? You are looking for the difference between two different types of loans. This blog is a perfect read for you. We will explain this with the help of various examples while keeping in view the Islamic finance laws and principles.

Below are the selected reasons to pick Islamic home loans over traditional.

Ownership Risk

Let's explain this with the help of an example; In Murabha home loan, that is the cost-plus model where the profit is already known to the client. The process starts when the client reaches the Islamic finance house. The client requested for financing facility to purchase or renovate a home after considering the application. Islamic bank (IB) will buy the house on behalf of the customer and then sell it. The risk remains with IB till the time of transfer of title.

In a conventional bank, the risk of the asset will be with the client from the first day. Not at any point, the bank will take any risk associated with the asset.

Monthly rentals

Islamic financial houses will begin to charge the profit at the transfer time when the house is in the client's possession. In Ijrarah finance, it is a lease-based product. The client can pay the loan amount in easy monthly instalments.

If a client Ijrarah financing facility, the monthly rentals will start when the client has the possession. Islamic banks can't charge profit before delivering the asset. However, monthly rental is not subject to its use.

In conventional banking, the bank will begin to charge Interest the day the contract start, whether the borrower has possession or not.

Fixed or variable rates

It is important to note here that both Islamic and conventional financial houses can charge fixed or variable rates depending on the feasibility of the borrower.

Before the contract starts, the fixed or variable rate will be mutually agreed upon. However, according to different observations, the conventional bank compounds the Interest if the client cannot pay the amount regularly.

It is not allowed in Islamic finance; the client can restructure the payment terms rather than compound the Interest.

Ownership and maintenance expense

In Ijarha finance, an Islamic bank or house will purchase the asset and lease it to the customer. Unless the lease period finishes, the investment title will remain with the Islamic institution. The Islamic house is the owner of the asset. It will be held responsible for ownership expenses. One of the most important is Insurance. This expense will be on behalf of the owner.

Conversely, in the case of a traditional home loan, the insurance expense is the total liability of the customer, who will bear all the costs associated with the home loan.

Operational Cost

There is a myth, Islamic home loans are cheaper than conventional home loans. The loan cost is almost the same or sometimes higher than traditional because of higher operational costs. This operational cost is subject to various economic and non-financial risks.

Penalty amount

Although it is the bank's responsibility to carefully monitor the borrower's financial health and take accurate risk measures, however, due to some financial loss or some accident client might not be able to pay the instalment in time.

In conventional, the bank will charge the penalty for late payment and consider it an income. Not only the loan amount, the penalty charges pocketed in the bank's revenue stream. Another example of how conventional makes money on money.

According to Sharia finance law set by highly reputable international bodies like AAOIFI: an accounting and auditing organisation. According to Islamic finance laws, banks or other institutions cannot take a penalty as this money is effortless money or Interest. As per law, the penalty amount is a contribution as a Sadqah or charity.

It is how Islamic finance also contributes to social and community development.

Sharia Laws Vs. Artificial laws

Islamic finance is monitored under Sharia laws, guidelines from Quran and Sunnah. Allah (SWT) and prophet Muhammad (PBUH) have clearly defined explicit rules for humanity.

An Islamic financial house owns the responsibility of following Islamic laws more strictly. Therefore, Islamic institutions are carefully monitored and watched by Islamic scholars. These scholars have Sharia knowledge and have a tight grip on changing dynamics of financial markets.

Customary laws are artificial; policies are made and monitored by the chairman or board members. There are no guidelines as per Quran or Sunnah. The purposes of these procedures are to maximize the Interest of the stakeholders.

The competition has been challenging for Islamic finance from conventional. Islamic banks and other wealth management companies like Afiyah Financial Services can offer Ijarah products that suit all customer needs whether it is to purchase a new home, build a home or invest.  We make every possible effort to meet customer demands and keep strict Sharia laws in line as well as spiritual needs.

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