The Islamic faith carries a number of principles that influence how Muslims conduct their personal finances, including when borrowing money to buy a home. Islam does not allow interest to be charged, and so traditional home loans aren’t suitable for Australians living by Islamic principles. Instead, specialised finance products are available.
To find out more, Canstar spoke with the Chief Operating Officer at Hejaz Financial Services, Muzzammil Dhedhy.
How does the Islamic faith affect personal finances?
There are many laws practising Australian Muslims may enforce when it comes to their finances. For instance, charging interest or investing in non-Halal activities is not allowed, which can make things awkward when it comes to securing a home loan.
“The laws of Islam govern every aspect of a Muslim’s life, including their financial activities,” Mr Dhedhy says.
“For example, Muslims are prohibited from investing in tobacco, alcohol, gambling, armaments, and [accessing] conventional financial services, such as banks that lend on interest or investment firms that invest in non-Islamically compliant investments.
“Similar prohibitions apply to financial products that can gain or lose substantial value, such as derivatives.”
What are the essential features of an Islamic home loan?
For a loan to be Sharia-compliant, according to Mr Dhedy, it must adhere to several requirements:
- The money used to fund the loan must come from compliant sources, such as Islamic or ethical investment funds.
- Loans may only be extended to borrowers engaging in Islamic-compliant activities, excluding the likes of casinos or breweries.
- Lending must be conducted using a unique contract, combining the requirements of Australia’s National Credit Code and the rules of the Islamic Ijara (an Arabic word meaning shared equity rental).
- The transaction must be conducted in a fair, equitable, and transparent manner between the financier and the customer.
How is an Islamic home loan different from a traditional home loan?
There are two key structures for an Islamic home finance product, which are known as Ijara and Murabaha.
Key features of Ijara financing:
“With Ijara financing, [the] financier provides financing to the customer, enabling them to acquire and use the property, with the client then making repayments to the financier,” Mr Dhedy says.
Repayments made this way are effectively split in two components:
- The Ijara rental component, in which the borrower pays the financier to use the property.
- The principal component, wherein the borrower incrementally increases their own interest in the property by paying down the debt.
This transaction occurs by way of a Finance Facility Agreement, which Mr Dhedy clarifies is not the same as a rent-to-buy scheme.
“This differs from a traditional home loan, in which a lender extends credit to a borrower who repays the loan with interest,” Mr Dhedy says.
Key features of Murabaha financing:
Murabaha financing, Mr Dhedy explains, is a method of Islamic financing commonly found in the Middle East and the Asian subcontinent.
It essentially sees the financier buying a home on behalf of the customer. The customer then agrees to buy the home for more than the financier paid in installments over a set period of time. The amount the customer will pay overall is agreed upon ahead of time. That’s different to how a traditional home loan works, where the total amount the borrower will pay to the lender is unknown, as interest rates can vary over time.
“[Under] a Murabaha agreement, the final repayment amount is pre-agreed between the parties, removing ambiguity and creating a higher degree of transparency,” Mr Dhedy explains.
If you’re considering this method of financing, it’s important to be aware that it can result in double stamp duty payments. That’s because the property’s title may change hands twice—once when the financier purchases it and again when the arrangement is finalised. If unsure, it’s likely worth seeking out independent advice.
What are some potential pros and cons of an Islamic home loan?
According to Mr Dhedhy, the key benefit of an Islamic finance facility is its foundation in faith-based values. “[There] is an ethical overlay applied to it, whereby both loan funding and loan purpose have an ethical requirement,” he says.
Additionally, these loans can hold their own in the broader market. Mr Dhedhy points out that Islamic mortgage products “can be highly competitive with rates offered by many conventional non-bank lenders, and in some cases, may be cheaper than those offered by non-Islamic lenders.”
However, borrowers should also weigh certain trade-offs. Chiefly, navigating the market requires an extra layer of effort. Dhedhy notes that Muslim customers will need to conduct careful due diligence when looking for finance products to ensure they are compliant, which he warns may limit their options.
Mr Dhedy also notes a broader limitation of Islamic lending, as some types of products that are not yet available in Islamic form, such as self managed super fund (SMSF) lending.
Who currently provides Islamic home loans?
Mr Dhedy says that there are a handful of providers who offer Islamic home loans in Australia, comprising both Australian Credit Licence (ACL) holders and their authorised credit representatives (ACRs). The latter tend to operate as private companies or community co-operatives, typically suburban brokerages that service subsets of their local communities.
What do you need to apply for an Islamic home loan?
Mr Dhedy says the requirements to apply for Islamic home finance are similar to those of a traditional mortgage application. As with a standard home loan, applicants will need to show proof of income in order to demonstrate borrowing capacity, and proof of savings for use as a deposit.
“The assessment process will consider credit history, employment details, dependents, expenses, liabilities, and property details,” he says. “Notably, being of Islamic faith is not a requirement for this process.”
