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Islamic finance has become a new trend in the global financial industry, and home financing is no exception. For many in the Arab world, it has become a welcome solution to borrow money in a Shariah-compliant manner to acquire a home as those of Muslim faith would not have to compromise on their beliefs doing so.
While a conventional home loan or mortgage comes with usual interest, this is fundamentally different in Islamic finance. Lending based on Shariah principles does not levy interest in any form, as interest as such is haram, but instead involves risk and profit sharing over an asset, in this case a property.
Borrowed money from Islamic lenders is always backed by an underlying asset, because they actually buy the property and lease it out to their client until it is paid off with pre-agreed leasing rates that include a profit for the bank.
''Since mortgages normally have a tangible underlying asset, they work well with Islamic financing,'' says Ashar Nazim, Partner at Bahrain-based Global Islamic Banking Center of consultancy EY.
''There are multiple options on offer including Musharaka [partnership] and Ijara [leasing] based contracts,'' he adds.
This leasing principle has a number of advantages, most of all a smaller risk for the homebuyer in case of payment problems. Islamic banks are much less likely to pursue foreclosures or repossessions as they own the property anyway, but tend to seek joint solutions together with the borrower.
Islamic home loans are also much more predictable in terms of repayment cycles because they normally come with pre-agreed rates over the entire lending tenure. And the more the Islamic finance industry has been working on developing products that can challenge conventional home loans in terms of product characteristics and flexibility, the more attractive they are getting not only to Muslim clients.
''There is no uncertainty [in Islamic finance contracts] and hence clients have peace of mind,'' says Pawan Dhawan, Head of Home Finance at Noor Bank.
''For example, the profit amount or rate is clearly spelt out in the agreements and does not change unless both parties agree to amend it,'' he says. ''This has proven rather advantageous especially for clients who had taken under-construction finance from the bank and even though the deliveries of the units were delayed, the profit amounts that they had to pay after years of delay were in line with what was agreed at the time of contract signing.''
No wonder Islamic home financing solutions have witnessed strong growth.
''The market share of Islamic home financing providers has been growing and as per our estimation now stands at approximately 50 per cent,'' says Gil Azevedo, Head of Consumer Banking at Emirates Islamic, adding that ''the penetration of Islamic home financing solutions is far in excess of the overall Islamic banking penetration in the UAE, which currently stands at 21.4 per cent.''
According to Azevedo, this is also a result of product sophistication and depth of options in Islamic home finance that are on par with conventional financing.
''Islamic home finance solutions today include the whole scope of property deals such as purchase of ready or under-construction property, self-construction of property, balance transfer from an existing facility to another bank, refinancing a fully owned property, debt consolidation under property finance facilities, commercial property financing, financing home improvement and renovations, as well as land financing,'' he says.
Shariah-compliant home financing also offers more protection to customers.
''If a property is damaged by fire, providers of Islamic home financing are obliged to freeze the customer's monthly installments since the property is deemed unusable and the customer ceases to benefit from the asset,'' explains Azevedo. ''It is also not permissible in Islamic financing that in the event of a delay in paying installments borrowers are charged fees on unpaid profit rates.''
It is, however, also noteworthy that Islamic home finance involves comparably higher arrangement costs and more paperwork. This has to do with the fact that many Islamic banks lack the economies of scale that allow conventional banks to reduce their non-interest costs such as staff and technology expenses. Islamic finance also typically includes more transactions than conventional finance to achieve the same goal, and has other overhead costs such as expenses for the Shariah advisory board.
EY's Ashar Nazim also points out that ''changes to an [Islamic] mortgage contract are usually expensive. ''For example, if a customer wants to pay off the full mortgage during the financing period, or wants to get it refinanced through another bank, there are penalties and costs involved,'' he says. ''This is unsustainable and will need to change.''
For Nazim, Islamic banks may need to ''redesign'' their mortgage service and deploy more digitally enabled solutions to attract a bigger segment consisting of young and first-time homebuyers.
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Source: Arno Maierbrugger, Special to Property Weekly