Insights On Islamic Home Financing: Advantages To Consider
Another privilege for home owners to make a choice in future
For home financing, conventional banks provide a loan to the homebuyer, and charge an interest on top of the principle as the cost of the funds. Beginning 2015, Bank Negara Malaysia (BNM) introduced the base rate (BR) to replace the existing base lending rate (BLR) as the indicative rate in Malaysia.
However, home loan as being practiced by conventional banks is not acceptable to the Shariah as the structure is a lending and borrowing on interest basis, whereby this is classified under the Shariah as a prohibited riba’ al-qardh. For Islamic home financing-i, the banks do not lend money and the homebuyers do not borrow. Instead, they form a business partnership to buy the house and hand it over to the homebuyer gradually.
Bank Islam Malaysia Berhad’s head of Shariah, Ustaz Mohd Nazri Chik said as an Islamic bank, they do not lend money to customer to purchase their houses. Instead, they provide the end financing to meet the requirement by way of Shariah compliant financing modes.
WHAT’S IN STORE?
He explained there are few types of the Shariah compliant modes such as Tawarruq (monetisation), Murabahah (cost plus sale), Istisna’ (purchase order sale), Ijarah (leasing) or Musharakah utanaqisah (diminishing partnership). “Currently at Bank Islam, our housing financing is structured under Tawarruq arrangement,” said Ustaz.
Bank Islam’s customers mostly approached the bank to get financing to pay their house vendors. Hence under Tawarruq arrangement, the Bank will sell commodities under Murabahah (cost plus sale) concept, at the price of financing amount plus agreed profit on deferred payment basis.
Subsequently the customer (via the Bank as its selling agent) will sell the commodities purchased from the Bank to the market, and the proceeds will be used to pay house vendor. The effects of the above arrangement are defined as customer would be able to pay the house vendor to get the house, who owes the financing amount with agreed profit to the Bank.
The financed house will be taken as security to guarantee the payment of instalments to the Bank. Additionally, customer may be required to subscribe to Mortgage Reducing Term Assurance (MRTA) or Mortgage Reducing Term Takaful (MRTT) to provide additional security to the Bank.
ADVANTAGES TO CONSIDER
In the event of customers delaying the instalment payments, they will not be imposed with compounding interest as practiced by conventional bank, instead they will pay a compensation that is computed on actual cost basis (ta’widh) as approved by the Shariah Advisory Council of Bank Negara Malaysia.
Ustaz added that what differentiates the Islamic home financing from the conventional loans are:
- It is not a loan, but a financing arrangement in compliance with the Shariah rules and principles;
- There are various modes of financing that can be structured, considering the legal framework, accounting standards and taxation of any particular jurisdiction;
- Customer will not be imposed any compound interest in the event of defaults, as it is not Shariah compliant.
Ustaz also explained that their advantages to take this Shariah compliant financing product, is that it would be Shariah compliant, offered in both fixed rate and floating/ variable rate financing. However, floating rate of Islamic financing provides more clarity and benefit to customers as it is capped to the agreed ceiling rate (as per the sale price of murabahah), in contrast to conventional home loan where the rate is moving up in tandem with the benchmark rate such as BR without any limit / ceiling.
He also shared that, “In Bank Islam, we offer ‘Payment Holiday’ feature for our house financing where our customers can pay 10 months of instalment in a year (January to October). This will allow our customers to have more cash in November and December in preparation for their children’ schooling, for holidays and more.” There will also not be any hidden or compounding charges. There are no apparent drawbacks as compared to conventional products offered in the market, thus bringing with it additional benefits as explained above.
Azmi & Associates partner for global financial services and Islamic banking, Farhah Hayati binti Mamat said generally, in relation to Islamic home financing, the Sharia law that applies are as follows:
- Istisna’: A contract for an order made by the buyer to manufacture / construct the asset / house per specifications.
- Bai’ Bithaman Ajil: A contract based on deferred sales price which is to be paid at a specified period. The financier will buy the identified house from the developer chosen by the buyer. The financier will then sell the house to the customer at a marked up price. The customer will make payments as per the agreed tenure in instalments.
- Ijarah Muntahiyah Bittamlik: A contract to lease the home for a pre-determined period. Finally, on lease payment, ownership of the home will be transferred to the customer in the form of a sale, promissory gift, or hiba.
- Tawarruq (Commodity Murabahah): A tripartite contract for the sale and purchase of the commodity made between the financier, the customer and the commodity trader. Upon the purchase of the commodity by the financier, the financier and the customer will enter into a murabahah sale contract where the customer is will pay the sale price on a deferred term to the financier. At the option of the customer and upon the completion of the sale of the commodity by the customer to the commodity trader, the customer will utilise the proceeds of the sale of the commodity to buy the house.
- Musharakah Mutanaqisah: A contract to finance the purchase of the house based on Shariah principles of diminishing Musharakah and Ijarah. Both the financier and the customer are co-owners of the house and with the payment of the Ijarah rental, the financier’s ownership of the house will be diminished and transferred proportionately to the customer at the end of the tenure of the financing.
In Malaysia, the Tawarruq (Commodity Murabahah) and Musharakah Mutanaqisah are the most acceptable products in Islamic home financing. Farhah affirmed “Islamic financial terms, ownership can be divided into two, i.e. legal and beneficial ownership. Legal ownership means the owner has an enforceable claim or title to an asset or property, and is recognized as such by law, specifically under the National Land Code 1965.”
Beneficial ownership is a legal term where specific property rights (“use and title”) in equity belong to a person even though the legal title of the property belongs to another person. Example of beneficial ownership is when a person buys a property but pending issuance of an individual title (especially when the purchaser purchases a strata property), he can lodge a caveat to the land, because he has a registerable interest over the land.
Farhah said “Islamic law recognises one’s ownership over the property, Muslim jurists define ownership as ‘the relationship that exists between a person and a thing that gives absolute control and right of disposal over it to the exclusion of others.”
In Islamic banking structure, the property ownership is one of the core principles that distinguishes between Islamic and conventional banking. Most of the Islamic banking products require the bank or financial institution to own the property first (as a beneficial owner) and rents or sell it back at a mark-up or with profit the customers.
Subsequently, the Islamic home financing will benefit non-Muslims in such that it is based on pre-determined profit rate instead of interest rate; hence, there is certainty in the amount of the profit rate. Also, it is based on base financing rate (BFR) which the bank can adjust based on prevailing market conditions but not more than the ceiling rate, which is the maximum profit an Islamic home financing provider will earn.
Then Ta’widh is charged at 1% per annum or at Islamic Interbank Money Market’s rate (subject to Bank Negara Malaysia’s guideline for Ta’widh) on the outstanding payment and it is non-compounding. For the conventional home loan, the average late payment charge is 1% on the overdue payment, compounding in nature and may subject to multi-tiered late payment charges rate based on the relevant period. There are no additional charges on the late payments.
Farhah pointed out the typical documentation involves letter of offer from the bank, with contents like profit margin, tenure, payment term etc, as well as the facility agreements (For example, in Bai’ Bithaman Ajil (BBA) facility, where the customer will first sell an asset to the bank, there will be two documents – Asset Purchase Agreement and Asset Sale Agreement are the facility agreements).
And then, there will also be the General Security Documents, which contain the land charge, deed of assignment over property, guarantee and debenture and memorandum of deposit.
While some of the stamp duty remission orders that are currently applicable are pursuant to the Stamp Duty (Remission Order) 2015 [P.U (A) 308/2016], the government is giving twenty per cent (20%) remission or discount of the stamp duty chargeable on a principal or primary financing instrument which is made in accordance with the principles of Shariah as approved by the Shariah Advisory Council; for the purpose of financing the purchase of a residential property; and executed between a financial institution and its customer from 1 January 2016 to 31 December 2017.
Another scenario is where the customer is only required to pay the nominal amount of the stamp duty. This will happen if the customer had previously had a conventional loan with the bank and wants to convert the existing loan to an Islamic home financing, or if the customer wants to restructure the existing financing facility.
Persuant to the Stamp Duty (Remission) Order 2014 and the Stamp Duty (Remission) (No.2) Order 2014, those principal or primary Shariah-compliant residential property financing instruments involving first time house buyers that have already qualified for 50% stamp duty remission will be further entitled to 20% stamp duty remission pursuant to the Orders.
In Malaysia, plenty of financial institutions are offering extensive Islamic home financing solutions, for example HSBC Amanah, Bank Muamalat, Maybank Islamic, OCBC Al-Amin, RHB Islamic Bank, Hong Leong Islamic Bank, Al-Rajhi Bank, Kuwait Finance House, Standard Chartered Saadiq, CIMB Islamic, Public Islamic Bank, Alliance Islamic Bank and Bank Islam.
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