Understanding Islamic home finance

Amjad NaserAmjad Naser

Today’s investors are no longer looking just at finance options when buying property. Ever since the financial crisis, investors have started seeking safer and more ethical alternatives while maintaining convenience when performing transactions. In this aspect, modern Islamic banks have an advantage over traditional institutions when catering to consumers, regardless of religious affiliation.

The principles of Islam

Islam is more than a religion. It’s also a system of life that deals with social, economic and political matters. Every Muslim is guided to live according to a legal code called Sharia. In financial matters, Sharia guides Muslims to act in accordance with the policies and guidance from Allah.

For instance, Islam does not restrict economic activity but instead directs it toward responsible activity that benefits other people and honours Allah. A key purpose for imposing these laws and ethics is to promote social justice and avoid any disputes that might lead to social and economic instability.

Why choose Islamic

Conventional banks lend money to borrowers to purchase their desired home and then charge them interest on the principal amount. For property loans, borrowers pay the interest rates at a fixed rate or based on a floating rate such as BLR or EIBOR. Repayment is then made in instalments over a set period, with a portion of each instalment going towards servicing the interest, while the remainder pays down the principal.

In contrast, Islamic finance avoids all interest-based transactions (known as riba), because Muslims are forbidden from earning interest, which is considered a violation of Islamic law and ethics. Therefore, Islamic banks have introduced a concept of buying the desired property and renting it to the customer for agreed rental payments throughout the financing tenure.

The property ownership is then transferred from bank to the customer after fulfilment of the entire financing obligation. This gives the advantage to the customer in the long run as the lessor/tenant, because the burden of major maintenance is transferred to the bank as the owner/landlord.

This is based on the concept of Ijarah, which refers to a lease contract on a specific tangible asset. This is an example of why Islamic finance is known as having asset-backed based facilities, as most of the contracts are structured on specific assets underlying the transactions. The majority of Islamic home financing options in the UAE today are based on this Ijarah concept. The lease contract for Islamic home finance is known as a Lease Agreement Ending in Transfer of Ownership.

Other alternative financing methods include sales and purchase based on the concept of Murabaha. This is where the bank buys a property and sells it to the customer at an agreed profit. In terms of the payment, a profit or rental rate, is clearly defined in the contract.

Additional benefits

Islamic banks are not allowed to charge their customers an additional profit payment in the event of late payments, which is an advantage to the customers. However, an Islamic bank may charge a fixed fee as a deterrent and preventive measure, which is clearly stipulated in the agreement. This ensures the customer is clear on what is expected if any late payment takes place and prohibits excessive uncertainty of attributes of a contract, in line with Sharia principles.

For Muslims who adhere to Islamic teaching and the Sharia, Islamic finance provides a safe and secure source of funds that are certified as halal (permissible and good). For non-Muslims, Islamic finance, with its asset backing and ethical principles, provides a real alternative to conventional, interest-based finance, something that is proving very attractive to people seeking a more wholesome banking experience.



Amjad Naser, Special to Property Weekly PW

The author is Head of Sharia at Noor Bank.


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