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Are Islamic finance products actually interest-free?
Islamic finance is often misunderstood. Here’s a look at the facts behind these faith-based loan products.
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Islamic or Sharia-compliant home loans don't charge interest in the same way traditional mortgages do. But this doesn't make them cheaper for the borrower. The existence of Islamic finance comes down to Islam’s belief that usury - or charging interest - is unacceptable.
As such, Muslims looking to borrow to buy a home while still remaining true to the tenets of their faith must look for other options. Islamic finance overcomes the hurdle of charging interest by instead purchasing a home in partnership and selling it back to the buyer over a pre-determined period of time.
Compare traditional mortgages here
This set-up isn’t charity, nor does it deliver borrowers an edge on traditional home loans. The way many Islamic finance products are structured, the lender will co-purchase the property with the borrower. The borrower will then make weekly rental payments that are calculated as a percentage of the original purchase price of the house. In so doing, they purchase the lender’s share of the property with a lease-to-own agreement.
Rent for the property is calculated as a percentage of the original purchase price, and this percentage is determined based upon the lender’s cost of funds, fair market rents and operating and management costs. Because the lender is assuming some of the risk by legally owning a large portion of the property, this percentage can often be higher than current traditional home loan interest rates.
If we assume a rent that is 4.99% of the original purchase price (the current scenario presented on the website of MCCA Islamic Finance & Investments, one of Australia’s main Islamic finance specialists), a $350,000 lease-to-own agreement would see the borrower pay a total of $675,625.40 over a period of 30 years.
Now let’s compare this to a typical home loan wherein the borrower is charged interest. A look at the home loan calculator below shows that the total cost of finance for a 30 year home loan at a 4.99% interest rate is $675,625.40, the same amount a borrower would pay for a Sharia-compliant home loan.
This would seem to undercut the argument that Islamic finance provides Muslim borrowers with a leg up on the competition from the price perspective. But Islamic finance products are unique when it comes to risk sharing.
Because the borrower is buying equity in the home over time rather than assuming debt, they are more protected than in a traditional home loan. Citigroup chief economist Willem Buiter recently told the Australian Financial Review the products offered greater protection to borrowers than traditional home loans.
“If you have disruption in your employment you can stop buying equity in the house or even sell back what you have already bought – the chances of eviction and dispossession are much lower,” he said.
This would seem to offer an advantage to borrowers in Islamic finance arrangements. However, the products are not exclusive to Muslim borrowers. Any borrower, Muslim or non-Muslim, can access Islamic finance products. But because the products are often more expensive than traditional home loans, there is no real financial advantage. The primary selling point of Islamic home loans is an ethical one, not a financial one.
Compare a wider range of home loans from non-Islamic lenders
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Ask an Expert
It would be very helpful if you could list down the Islamic financers/lenders in Australia, with some basic information about their products.
Hi Mo,
In reference to Islamic banking institutions in Australia, we have more information available on our Islamic Home Loans page.
Unfortunately, right now, there are no Islamic home loans listed on this page, but this provides some general information on these loans. MCCA is a Shariah-compliant finance and investments provider; they may be able to provide you with some more info also.
Cheers,
Sarah
Sir mujhe home loan ki jarurat he sir
Pliss Sir
Hi Mohd,
Thanks for your inquiry.
If you are searching for a home loan in Australia, you may refer to our list of latest home loan offers. On the page, is a comparison table you can use to see which lender suits you.
You may click the name of the lender or the “More info” link to be redirected to our review page and learn more about the lender’s loan offer, rates, and requirements as well as the pros and cons of using their loan service. When you are ready, you may then click on the “Go to site” button and you will be redirected to the lender’s website where you can proceed with the application or get in touch with their representatives for further inquiries you may have. Alternatively, you can speak to a mortgage broker who can take your personal circumstance into account and offer you a range of borrowing options.
If you are looking for a home loan in India, I’m afraid we don’t have a dedicated page yet for a list of lenders in your country. You may reach out to your local bank or credit union instead.
Before applying, please ensure that you meet all the eligibility criteria and read through the details of the needed requirements as well as the relevant Product Disclosure Statements/Terms and Conditions when comparing your options before making a decision on whether it is right for you. You can also contact the provider if you have specific questions.
Hope this information helps
Cheers,
Arnold
What is the percentage of deposit?
Hello Tanvir,
Thank you for sending your question. :)
Most Islamic home loans still require 20% deposit. Please take note that this may vary per lender and would also be dependent on your credit status.
Hope this helps.
Cheers,
Jonathan