What Are The Advantages Of Taking Islamic Property Financing?

Islamic home financing

Islamic banking and financing, particularly Islamic property financing, in Malaysia is considered one of the most renowned and established in the world. Islamic banking which follows Shariah laws has been in operation since the enactment of the Islamic Banking Act in 1983 and the establishment of Bank Islam Malaysia Berhad on the same year.

The new law and the institution of a new bank paved the way for the continuous development of Islamic banking and finance in Malaysia.

How does Islamic financing work?

In a nutshell, Islamic banking is a system that follows Islamic Laws (Shariah) principles and Islamic-based economics. Islamic principles dictate that money lending (interest-based) as well as investing in businesses that are considered haram (unlawful) are prohibited.

Conventional financing profits by charging interest on the loan, meaning that borrowers will end up paying back more than they borrow.

Islamic financing is instead based on making a profit through the sale of commodities. Basically, the buyer asks the bank to buy the exact item that they want financed, which is then sold to them at an additional markup.

The buyer is then asked to pay for the item in instalments or through a “rent-to-own” scheme. All this is known as the principle of Murabahah and is basically the concept of providing financing to consumers based on pre-determined profits rather than dealing with interest.

How does that apply to property financing?

Under Islamic property financing, banks are required to buy an asset (i.e. property) from the seller and sell it back to the buyer (you) with profit. The buyer will be allowed to pay for the property in instalments.

In Malaysia, banks tend to prefer the reverse Murabahah or Tawarruq method for financing property. For this case, the bank financing funds come from the transaction of commodities.

This means the buyer requests for funds to buy the property. The bank then purchases commodities for the buyer with a value equal to the financing amount and sells it to the buyer at a profit. The bank then arranges to be repaid in instalments.

At the same time, the buyer arranges for the bank to sell the commodities to a third party for the value of the financing amount. The proceeds of this sale are then transferred to the buyer to purchase the property.

Technically, it works in a similar fashion to a conventional home loan where the customer pays 10% down payment (customer’s equity) and the bank will finance the balance of 90% (bank’s equity).

For more information on the difference between Islamic and conventional financing, see Types of home loans in Malaysia.

What are the advantages?

Essentially, Islamic banks follow two types of Islamic banking principles – Bai’ Bithaman Ajil (BBA) and Musharakah Mutanaqisah (MM).

Bai’ Bithaman Ajil (BBA)

BBA is based on the Murabahah concept previously discussed and is the most popular option for home buyers looking for financing.

MM is a partnership formed between the bank and the customer in order to buy the property.

Under the MM partnership, the both the customer and the bank have an equitable interest in the property. It is then up to the customer (i.e. you) to buy over the bank’s share of the property through instalments.

Musharakah Mutanaqisah (MM)

MM is a newer option and we will primarily look at advantages as well as drawbacks of this partnership.

Advantages of Islamic property financing

Other than providing greater social and moral responsibility and fairness, Islamic property financing offers quite a few advantages, such as:

  • Fixed monthly repayment to help customers balance their monthly budget.
  • Cost of stamp duty lower by 20%. This 20% stamp duty discount for Islamic financing agreement documents is still in force as part of the government’s efforts to promote Islamic financing. Furthermore, stamp duty is waived for the redeemed amount when refinancing from a conventional loan to an Islamic home finance.
  • Penalty fee for property disposal within the lock-in period can be potentially lower than a conventional loan. A conventional loan’s penalty fee for early settlement (prepayment) is a set percentage, whereas the Islamic bank will charge based on the bank’s prevailing cost of funds. However, the fee differs from one Islamic bank to another.
  • Unlike conventional loans, which are based on Base Lending Rate, Islamic loans are based on Base Financing Rate (BFR) which the bank can actually adjust based on prevailing market conditions but not more than the ceiling rate, which is the maximum profit an Islamic finance provider will earn.

[Block]The 20% stamp duty discount for Islamic financing that was implemented during Budget 2007 has since been discontinued.[/block]

What are the drawbacks?

There are two sides to every coin, and though the good seems to outweigh the bad, here are some of the main weaknesses of Islamic property financing:

  • The floating rate penalty charge may be less desirable during the high interest rate regime.
  • Even though the concept is sound, the calculation method adopted by each bank differs significantly. Though the outcome may not be detrimental to the bank or the consumer, due to the restriction in procedure, a degree of uncertainty exists for both the bank and the customer.
  • Alteration of terms of financing may be more troublesome. Should a customer choose to alter the terms of financing, a new Sale and Buy-back agreement needs to be created and signed. A conventional loan would only require the amendment to be stamped which incurs less cost.

Boosting take-up of Islamic property financing

In recent years, Malaysia has maintained its position as the global leader in Islamic finance.

According to Bank Negara, Islamic banking industry’s share of total financing in the financial system increased from 44.5 per cent in 2022 to 45.6 per cent in 2023.

The global Islamic finance industry is expected to reach US$5.9 trillion by 2026. Malaysia continues to lead with its strength in Islamic finance ecosystem such as awareness, knowledge and sustainability.

Fitch Ratings has also forecasted that Malaysian Islamic banks to continue to outpace that of conventional banks in the medium term. According to their report, Malaysia’s Islamic financing had reached USD190 billion in 2023, cementing the country’s Islamic banking market as the third-largest globall

Getting financing for a home loan can be a headache. Eliminate the hassle by applying through iMoney. Compare and find the best Islamic home loan rates to begin.

This article has been updated on July 15, 2024.

Get free weekly money tips!

*Free of charge. Unsubscribe anytime.
newsletter image