Islamic finance is based on the premise that money by itself shouldn’t hold value. Rather money in the Islamic faith is just a way to exchange products and services with value.
Home loans are one aspect of personal finance that the Muslim community has to navigate with some challenges. For example, an Islamic financier cannot charge interest on a home loan.
Islamic home finance allows you to purchase your property with financial products that accrue interest differently. Nevertheless, in Australia, credit laws apply, and every credit provider with an Australian Credit Licence is bound to charge you for borrowing money.
If you aren’t comfortable opting for a traditional home loan, you could benefit from Shariah-compliant products available for construction and buying vacant plots, though not for refinancing. These Islamic home loans have complete doc and low doc options, depending on your leasing needs.
With a significant and relatively youthful Muslim population, Australia is opening up to the untapped Islamic finance market, estimated by news platform Salaam Gateway to be worth $248 billion.
This article contains further information to enable you to buy your Islamic home per sharia principles.
Is it Haram to Get a Loan for a House?
For many Australians, seeking a mortgage is a common step toward owning a home.
Islam provides specific guidelines on financial practices. One of the key reasons many Muslim scholars and leaders consider traditional home loans haram (act forbidden by God) is the involvement of (riba) interest.
Followers of Islam faith cannot invest in alcohol, tobacco, gambling, weapons, and traditional financial products and services that charge interest or companies that invest in non-Islamic investments.
Muslims want to ensure that they are not compromising any values when taking a loan. Therefore, replacing interest with a profit-sharing model serves the purpose of Islamic home buyers.
What are Sharia-Compliant Home Loans?
Sharia principles support Islamic finance. In Australia, even non-Muslims can access home loan credit products.
To be Sharia compliant, Islamic home loans are aligned along with the following principles:
Forbidden to pay or receive interest
Charging or paying market interest rates (riba) in any financial transaction is banned under the rules of the Islamic faith.
Uncertainty is forbidden
Gharar, which means uncertainty, is forbidden under Sharia as it implies risk and deception and is contrary to the idea of openness in business transactions. Islamic home loans reject ambiguity, while risk-taking is allowed only if leasing terms are agreed upon by all those involved.
Fair sharing of profit and loss
Sharia-compliant loan transactions must be implemented in an open, just, and equitable manner between the home buyer and financial institution.
Musharakah is a partnership in Islamic finance wherein partners share in the profits and losses of the enterprise.
In an Islamic home loan, a partnership is set up. The parties mutually agree to contribute to the capital of the partnership venture and agree to share the profit or loss related to the deal.
Gradual buying of the whole part of a property
Musharakah Mutanaqisah is a partnership contract between two parties. One partner gradually purchases the whole parts of the said property in the form of rental payments until the equity title is transferred in full to the home buyer.
How Does an Islamic Home Loan Work?
One of Australia’s more common models of Islamic home loans is Ijarah Muntahia Bittamleek. If you plan to take an Islamic home loan, you will first have to choose your own home, and then the financial institution will buy it from the seller.
The financial institution will then enter into an agreement for a predetermined lease period of the home, during which you will pay rent to your lender.
Your lender will calculate their “profit” component to cover the full finance term, including the sale price. The financial institution makes money by leveraging the financing arrangement instead of charging you interest. In principle, you then are not paying interest.
During your final lease payment, the home or property owner will be transferred in your name in the form of a hiba or a promissory gift. As a result, you will no longer be required to pay rent.
In this way, Islamic home buyers get registered as homeowners on the settlement date. The financial institution has taken the mortgage from the customer while securing a transaction agreement that excludes any mention of principal or receiving interest.
Islamic home loans financing features are pretty similar to an operating lease while retaining the essence of better alignment with Sharia principles.
If you are looking for financing alternatives to buy your own home responsibly, aligned with Islamic principles, you could consider Islamic home loans instead of a traditional home loan.
How Do Islamic Home Loans Differ From Traditional Financing?
Ijara (lease) and Murabaha (sale with profit component) are the primary Islamic home loan product models.
When you opt for Ijara Islamic home loans, your property purchase is customarily financed through a mortgage agreement that helps you buy and use the property. In simple words, your home will be financed using the funds borrowed from your lender.
As a borrower, you will have to repay this home loan amount which comprises the Ijara’ rental component’ for using your financier’s equity interest in the new property and a ‘principal component’. Consequently, as a borrower, you start to increase your equity in the property with repayment of the principal amount of your debt.
This system is different from a traditional home loan, where your lender would first offer you credit, and you would then need to repay the loan with interest.
Murabaha (sale with profit component)
In the second model, i.e., Murabaha financing, which is popular in the Middle East, the system involves a contract an Islamic financier, upon the request of a customer, buys the property from the seller and then sells it to the home buyer with a pre-fixed profit margin. The Islamic home buyer then starts making regular payments of an agreed amount over a preset period.
This Murabaha Islamic financing differs from a traditional mortgage in that the financier does not provide you money to purchase your own home. Instead, your lender will buy the asset and sell it to you.
Under a traditional loan agreement, where there may be uncertainty about the final amount you have to repay over the loan term, you and your lender will agree on the final repayment amount in a Murabaha agreement, thus operating with clarity and transparency.
With an Islamic home loan, technically, your home is owned by you from the beginning. However, it comes with a legal agreement that your Islamic lender is entitled to it. If you default on your home loan, your lender can sell your property and recover the outstanding funds.
Regarding stamp duty, insurance, and such costs, your lessor may agree to manage these expenses when purchasing the property on your behalf. Alternatively, you may have to work this part on your own.
If your lender pays for stamp duty when purchasing property, the amount will be included in your overall lease. Stamp duty and capital gains tax implications have also been addressed in recent industry developments.
According to one of the leading lenders, once the home buyer has repaid the amount in total, it automatically addresses tax implications since there’s no actual transfer of title.
To summarise, the key differentiator between a regular home loan and Islamic home loans is home loan borrowing terms and conditions. (i.e., interest with a traditional home loan and rental or profit fee with Islamic home loans). Your financial institution makes money by charging you a profit rate on your rental instalments.
What to Consider About Sharia-Compliant Home Loans
When applying for Islamic home loans, understanding the options available will help you make calculated decisions and settle down on a home loan that matches your own circumstances and financial situation.
Consider these factors in your when looking for Islamic home loans:
- Applicability: Before starting the application process for a Sharia-compliant loan, read up on the legislation, especially stamp-duty-related legislation in your state. Understand the total costs involved and other terms and conditions of the different lenders and seek independent advice if needed. This will help improve the chances of your application getting approved.
- Deposit: When looking out for an Islamic home, think your budgets over carefully. The rules regarding the deposit size you will have to contribute vary with different lenders based on the value of the property being purchased. You should also know that lenders charge different rent rates once you move into the new home. Studying the rates of the different lenders and checking if there are any additional fees involved will give you much-needed clarity on the options available.
- Choice of lenders: Though Sharia-compliant loans are not as popular as traditional home loans, consider the maximum options possible by looking at traditional Islamic financiers and the larger Australian banks that have started offering Sharia-compliant loans.
- Early repayments: Check if your lender will allow you to make a lump-sum payment in the future. Many home buyers prefer to reduce their debt exposure as early as possible, and early pre-paying facilities can help you get full ownership of your home earlier.
- Loan to Value Ratio (LVR): This is the amount of the property purchase price or value that you can borrow with your lender. Having an LVR of 80% or lower will enable you to borrow a considerable amount with lower repayments and spare you the extra cost of the Lender’s Mortgage Insurance. Check out our resources on LVR and LMI to know how they impact your home loan costs.
- Repayment frequency: Research the frequency options - weekly, fortnightly, monthly - being offered by different lenders to make your rental repayments. Knowing the options can impact your choice, and you can pick a Sharia law-compliant home loan product that suits your income and financial situation.
- Rental costs: While interest is not charged for an Islamic home loan, you will still pay a profit charge or rental payment to the financial institution. Ensure that you have complete clarity on the exact amount you will be charged due to the profit rate.
- Service Fees: In some cases, the home loan product provider may charge annual fees that will increase the amount of your rental payments. A thorough study will help you identify financial institutions with minimum or no ongoing fees. This will help you get to the finish line much quicker as you focus on your rental repayments and pay out the lease faster.
Benefits of Islamic Home Loans
- Sharia law-compliant: Obtaining a home aligned with Sharia law offer you an opportunity to buy your own home in keeping with your religious values. Ethical requirements underpin the loan funding and purpose of the loan.
- More affordable loans: You can access home loan products at highly competitive rates offered by reputed non-bank lenders. In some instances, these products may be cheaper and more affordable than those provided by non-Islamic lenders.
- A sustainable option: You’ll generally be offered the same features as a regular home loan and protected by the National Consumer Credit Protection Act. Some Islamic home loans can help you get your property ownership sooner. You may also have the advantage of choice, with some lenders offering you lower repayments for lease payments.
- Get pre-approved. Some lenders will approve your application in advance. This allows you to choose a home within the price range immediately you have agreed upon, accelerating your loan application process.
Limitations of Islamic Home Loans
- Fewer options: Some types of lending products, SMSFs (self-managed super funds), are not yet available in an Islamic version. In addition, when picking up Islamic Home Loans, you will also have to run due diligence on the products to check for compliance issues, further limiting your options.
- May work out more costly: Given the uniqueness of Islamic home loans and the relatively limited market size, some lenders may charge you more than a regular home loan in the form of profit.
- Full Doc: Lenders providing these types of home loans operate under the National Consumer Credit Protection Act. They are obligated to run independent checks about your ability to meet your financial responsibilities comfortably. This implies that Islamic home loans include a “full doc” application process.
Banks that Offer Islamic Home Loans
In Australia, you can access the different types of Islamic home financing offered by a limited number of service providers in Australia. These lenders include Australian Credit Licence (ACL) holders and the authorised credit representatives (ACR) of ACL holders. They operate as private companies or community co-operatives and many are suburban brokerages that cater to sections of local communities.
Financial institutions in Australia offering Islam-compliant products and services include Amanah Islamic Finance, Hejaz Financial Services, Iskan Finance, MCCA Islamic Finance and Investments, Equitable Financial Solutions (or EFSOL), and the Islamic Cooperative Finance Australia Limited (ICFAL).
A few foreign banks in Australia offer Islamic home loans. You could also consider non-Islamic lenders that offer Islamic home loans and choose a credit provider that gives you home loans that cater to your personal circumstances and is in keeping with the Sharia law.
NAB Sharia-Compliant Home Loan
NAB recently introduced a Sharia-compliant financing contract aimed at business bank customers. The product targets transactions over $5 million for the purpose of commercial property construction.
It does not include personal loans or home loans, investment financing, or stand-alone business acquisitions.
What You Need to Apply
Islamic home loans are typically offered as full-documentation products. When seeking your Islamic home loan, the application process is quite similar to applying for a traditional mortgage.
You will have to offer proof of income to show your borrowing capacity and evidence of the proposed deposit amount that you will contribute. Along with your employment details, the assessment process will include a review of your credit history, dependents, assets/property, expenses, other debts, and liabilities.
Where Joust Can Help
Joust’s Instant Match is a great way to connect with Australia’s most reliable and reputed home loan lenders.
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Even better, you are under no obligation to proceed because, as one of Australia’s leading online home loan marketplace, we want to show you that we are committed to getting you a suitable home loan.