You can fulfil the dream of buying a home while living in accordance with Islamic law.
Islam prohibits interest being charged on home loans, which makes it difficult for someone of Islamic faith to find the right home loan that’s consistent with their religious beliefs. While Islamic home loans enable you to finance your own home- Australia’s lending laws still apply.
Islamic home loans are available for many purposes such as construction and purchasing vacant land, although they are not typically used for refinancing purposes. They also come in full documentation and low documentation versions, depending on your leasing needs.
With an Islamic home loan, you can choose the home and then the financial institution will buy it from the seller. This same financial institution then makes an agreement to lease the home for a pre-determined period of time, which is known as Ijarah Muntahiyah Bittamlik. At the time of the final lease payment, ownership of the home will be transferred to you in the form of a promissory gift, or hiba.
As General Manager of Iskan Finance, Russell Murphy confirms: “For our customers, at the date of settlement, they are registered as the owner. We’ve taken the mortgage from them, and secured a transaction agreement that doesn’t express principal or interest.”
“This style of mortgage financing has many of the hallmarks of an operating lease with the object of better alignment with Sharia law, hopefully providing financing alternatives for Muslim’s otherwise uncomfortable to pursue home ownership.”
What place do Sharia-compliant home loans have in the Australian market?
With just 1.7% of the Australian population being Muslim, there are limited Sharia compliant home finance programmes on the market.
However, according to Ernst & Young (2010), Islamic banking assets have experienced rapid growth and are forecast to increase by an average of 19.7% a year until 2018, and a number of Australian financial institutions have examined Muslim financing concepts such as profit sharing and rent to buy, whilst trying to avoid terms such as ‘interest’ in contractual agreements.
Which core Sharia principles come into play?
Islamic finance is underpinned by Sharia values that are consistent with Islamic legislation. The fundamental principles concerned with Islamic home loans are outlined below.
Prohibition of paying and receiving interest (ribā): Interest cannot be charged or paid in any financial transaction under Islamic law.
Prohibition of uncertainty (gharār): While ambiguity is forbidden, risk-taking is permitted when the leasing agreement terms are clearly laid out between all parties involved.
Profit and loss sharing: Under Islamic law, all parties must share the risks and rewards associated with the financial transaction.
Musharakah (profit and loss sharing partnership): Under this contract, a partnership is established in which the parties agree to contribute to the capital of the partnership and agree to share the associated profit or loss.
Musharakah Mutanaqisah (diminishing partnership): This is a musharakah contract in which one of the parties agrees to purchase the equity share of the other party in the form of rental installments until the title of equity is transferred to the buyer in full.
How does a traditional home loan differ from an Islamic home loan?
The purchase of a property is typically financed through a mortgage agreement where the property is financed through borrowed funds from the lender. The borrower is required to repay this loan amount, plus interest, via a predetermined repayment schedule.
The bank has security over the property, which means that if the borrower defaults on their home loan, the lender can enforce a sale of the property to recover the outstanding funds that are owed.
In contrast, some of the earlier Islamic home finance programmes in Australia involved the institution partnering in the purchase of the property and then selling it to the buyer at a cost plus profit, or joining in a capital gain on sale. For the period of the transaction, the buyer amortised the outstanding debt through rental installments.
More recent product developments, however, have had stamp duty and capital gains tax implications, and have looked to the Islamic principles of Ijara (lease) or Murabaha (sale with profit) where the financial institution enters into a virtual rent to buy arrangement with the buyer over a specified time frame.
Mr Murphy states: This means that every rental payment the customer makes will increase their equity in the property and subsequently decrease the provider’s equity. Once the customer has fully repaid the amount, there’s no actual transfer of title involved and this addresses tax implications.
“Islamic finance is largely about the philosophical side of things- it’s where Western banking meets Islamic banking. We offer an alternative solution for Muslims in an Australian landscape.”
“Ours is a common mortgage transaction that’s fully functional. It has all the bells and whistles of a traditional banking facility, such as an offset with a debit card attached to it and the ability to transact over the internet, but the main difference is that although we refer to capital, we don’t express principal and interest. Rather, we charge a rental facility fee.”
“In a highly regulated environment you have to be pragmatic about what you can, and can’t offer. When people have English as a second language, you have to place yourself on the moral high ground, as people often misunderstand what they’ve been told, so National Consumer Credit obligations aside, we’re very careful to disclose all the costs involved.”
Therefore the fundamental difference between a typical home loan and a Sharia-compliant home loan is underpinned by the borrowing terms (i.e. interest with a typical home loan, and rental or profit fee with an Islamic home loan).
Aaban wants to own a home in Australia
As a hard working Australian resident, Aaban has decided that he would like to settle down and buy a home in the outskirts of Auburn, Sydney.
As the Islamic religion forbids borrowing money to be repaid with interest, Aaban approaches a local financial institution that provides alternative forms of lending. The lender conducts a preliminary assessment of Aaban’s financial situation and issues a conditional letter of approval on behalf of the funder.
The property he’d like to purchase is valued at $310,000 and with his $60,000 deposit, he needs help coming up with the $250,000 difference, before the house can be transferred to him.
With the lowest variable rate offered by the lender of 5.2%, he’ll have to pay an extra $197,225 on top of the $310 000 principal over 25 years. Aaban enters into a rent to buy mortgage agreement and his monthly rental payments are made through direct debit from his nominated bank account.
A representative from the financial institution tells Aaban that as he makes rental payments, the funders’ equity in the property will diminish whilst Aabans equity will increase so that by the time the debt is extinguished, or if he wishes to sell in the meantime, ownership of the property transfers solely to Aaban.
How to compare Islamic home loans
Mr Murphy stresses that when comparing Islamic home loans, you keep an eye out for the service level offered by the provider :
“Just like any conventional facility in any other organisation, customers should be alert to the service aspect of the product. I believe Iskan Finance operates as an ethical business and we’re firm on NCCP (National Consumer Credit Protection Act) compliance so people should take the comfort in the fact that we, and other providers, respect people’s rights under Australian law.
Additionally, Mr Murphy recommends that you conduct thorough research regarding the regulations, laws and associated costs of a home loan:“Do your research and have a look at the legislation in your state, particularly in regards to stamp duty. We always ask the customer to have a chat to a conveyancer so they fully understand what the costs will be. There’s no point in slapping together an application that has no chance of approval, so we teach people the discipline of submitting an application that will be approved.”
Islamic home loans come with many of the features that are also offered with traditional home loans. Compare the features among different lenders before deciding which home loan is right for you.
Early payoff. You should ensure that you may make a lump sum payment in the future. Mr Murphy says that the vast bulk of Iskan customers are happy to pre-pay their facilities if they are able to do so “It doesn’t matter whether it’s a customer of Iskan or any other institution, people are wary of exposure to debt and we find customers are pre-paying their way out of their mortgage as a common defensive strategy” .
Loan to Value Ratio (LVR). The LVR ratio refers to the amount of the property value or purchase price you can borrow with the lender. A loan with a high insured LVR allows you to borrow funds without paying Lender’s Mortgage Insurance (LMI).
Repayments. There should be options for the frequency in which you make your repayments to the financial institution. Look for a lender that offers weekly, fortnightly or monthly payments so you can arrange your payments to suit your income.
Rate. Although technically interest isn’t charged for an Islamic home loan, the financial institution will still be charging in the form of a rental or perhaps profit. Make sure you have a clear understanding of exactly how much extra you’re being charged as a result of the profit rate.
Ongoing Fees. Some institutions will charge annual fees which will increase the amount of your payments. Look for financial institutions with low or no account-keeping fees so you can focus on meeting your repayments and paying out your lease in full.
Things you should consider about an Islamic Home Loan
Sharia acceptance. This alternative method of obtaining a home is designed to better align with sharia law to offer Muslims a means of pursuing home ownership without offending their religious values.
Features. In most cases you are offered the same features as a typical home loan. Some of these help you in achieving property ownership sooner, while others can give you the option of lower payments if you make lease payments only.
Pre-approval. Your lending institution may approve your circumstance beforehand, allowing you to immediately choose a home that is within the price range they agreed upon, thereby facilitating your application process.
Could be more expensive. The unique circumstances surrounding an Islamic home loan and the limited size of the market can make lenders charge more compared to a typical home loan in the form of a profit.
Documentation. The providers of this style of finance all operate under the National Consumer Credit Protection Act and are unambiguous about obligations to make independent enquiries as to a your ability to meet the financial commitments without undue hardship. This often means Islamic finance comes in the form of a “ full doc” application process.
Are there any Islamic banking institutions in Australia?
While there are several foreign banks in Australia, including the Arab Bank and HSBC, few of them offer Islamic home loans. However, Westpac and National Australia Bank (NAB) have introduced Shariah compliant products to the market. In 2010, Westpac introduced a Special Interbank Placement for Islamic Financial Institutions while NAB offers an interest-free personal loan for low-income earners that receive Centrelink benefits, which could be an alternative for Islamic Australians. Currently, the main Australian financial institutions offering Sharia-compliant products or assistance are Iskan Finance, Equitable Financial Solutions, Amanah Islamic Finance, the MCCA Islamic Finance and Investments, and the Islamic Cooperative Finance Australia Limited (ICFAL).
How do I qualify for an Islamic home loan?
Generally Islamic home loans are offered as full-documentation products. This means you’ll need to provide evidence of funds for your deposit, your savings history, employment history as well as information related to any other assets or liabilities you have. In regards to Iskan Finance and their application process, Mr Murphy states: “We generally start the application process with a deposit equation. We’re inclined to let the customer know that there will be costs accountable such as stamp duty, legal fees and conveyancing costs.”“As full-doc loans, people need to have adequate income and they need to be able to document their income. We talk about what will happen over the next 30 years or so, we discuss how they’ll set their lease payments and whether or not they like the arrangement is up to them to decide.”
Frequently Asked Questions (FAQ)
No, there is no restriction on non-Muslims taking out Sharia compliant home loans however as there is no financial benefit to non-Muslims its not often an option offered to them.
There are no significant commercial benefits or features of Islamic home loans that wouldn’t be offered with a non-Islamic compliant loan.
Some argue that Islamic finance simply interchanges terminology and concepts, where Sharia-compliant home loans don’t differ greatly from standard home loans. This is because they believe that both Islamic and conventional banks make the same return, except conventional banks label it ‘interest’ while Islamic institutions label it ‘profit.’ However, you must consider additional concepts such as risk-sharing and the absence of ambiguity which make Islamic home loans unique, compared to traditional loan products. On this subject, Mr Murphy states: “In the Australia, the Muslim community comprises of Pakistanians, Fijians, Indians, Malaysians, Egyptians, and so on. It would not be uncommon for some people to come to me and say ‘I want my Imam to sign off on your program’. But then we’d have to do the same for everyone and try to represent all the different religions, which would be impossible. We offer an alternative product and it’s up to the customer to decide whether or not this fits with their philosophical agenda.” Ultimately, it’s up to you to interpret the concepts of Islamic finance and decide whether or not the product is consistent with your beliefs.
No. Islamic home loans do not charge or express interest. The way it works is that the financial institution mortgages the property and charge you an amount which you pay in rent.The more funds you repay, the more ownership you have in the property, until it is paid off in full. Keep in mind that just because they don’t charge interest, doesn’t mean they don’t charge a profit. The financial institution still makes a profit from leasing the property to you.
When it comes to stamp duty, insurance and other costs, the lessor can agree to handle these expenses when they buy the property on your behalf, or it may be up to you to handle them. If the financial institution pays for stamp duty at the initial stage of buying the property, keep in mind that the stamp duty amount will be added to your overall lease. However, Mr Murphy provides insight regarding Iskan Finance and their treatment of stamp duty and associated purchase charges: “It’s treated the same as any contemporary mortgage facility, when the customer turns up, depending on how much equity they have, they have to provide the sufficient funds to pay the deposit, stamp duty, valuation and other charges. However, if they’re require less than 80% LVR, the financial institution generally absorbs the cost of LMI.” Keep in mind that the requirement for stamp duty will differ depending on the state in which you reside. However, in NSW, there are no special exemptions for stamp duty regarding Islamic finance transactions.
The nature of the lease payments depends on the lease structure that is set out by the leasor. The agreement will also set out what happens to your rental payments when market interest rates fluctuate. Generally, it’s not possible in Australia to provide a fixed rental for the entire term of a mortgage.
Depending on the financial institution, Islamic home loans may be slightly more expensive than non-Islamic home loans. However, this will depend on the way in which the financial institution determines the profit made on the sale.
The financial institution makes money by charging a profit rate on your rental installments.
With some lenders such as Iskan Finance, it may be possible for you to conduct home improvements on the property. According to Mr Murphy at Iskan Finance: “Capital gain will belong to them solely because they own the property so they can benefit from any capital gain they make.”
Generally, the financial institution will need you to supply proof of your income and ability to meet your rental payments, proof of funds to complete the deposit as well as a minimal rental deposit if you intend to live in the home.
During the lease period, the property remains ownership of the financier but you have the right to use the property until expiry of the agreement period, when the ownership of property is transferred to you in the form of a gift given that you’ve repaid the amount in full.
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