Australia is home to a wealth of cultures, with the vibrant Islamic community one of many that continue to grow. An important component to Islamic culture is the financial principles underpinning Islamic home financing.
Before we get into the details of Sharia-compliant finance products, it's important to note that they’re typically not referred to as ‘loans’. However, as the terms ‘financing’ and ‘lending’ are often used interchangeably within the Australian financial space, both terms are used in this article.
What is an Islamic home loan?
The underlying principles of Islamic finance state one must work for any profit, and simply lending money to someone who needs it does not count as work. Additionally, under Islamic or Sharia law, money must not be allowed to create more money.
This is known as the principle of ribā. It is often considered to mean money is strictly prohibited from earning or accruing interest. That’s because neither you, nor your financial institution of choice, are believed to have worked to earn said interest.
The interest-based home loans that dominate our market generally allow people to borrow money from a bank, which can be used to buy a house, and then pay the money back, plus interest, over a fixed term.
Conversely, under the principles of Sharia law, Islamic home loans allow you to finance your property purchase with an alternative product that doesn’t accrue conventional interest.
How do Islamic home loans work?
Like any home loan, Islamic loans start when you choose a property. From there, the process is tailored specifically to Islam, with your financial institution agreeing to purchase it for you. In return, you make a Ijarah Muntahiyah Bittamlik or ‘lease’ agreement to live in the property for an agreed length of time and pay rent to the institution.
At the end of this agreement, the institution will transfer ownership of the property to you. The principle of Ijarah Muntahiyah Bittamlik means that you are never actually in debt, yet you have a secure home that you will ultimately own.
Alongside Ijarah Muntahiyah Bittamlik, there are other Sharia compliant Islamic home loan options to assist you in purchasing a property.
Mudarabah
Translated as ‘profit-and-loss sharing’, Mudarabah is similar to a partnership where one partner lends money to another to invest in a commercial enterprise. The terms of Mudarabah state the first partner invests in the enterprise while the other has the responsibility to manage and work on the investment. By doing this, each partner shares responsibility for the ‘loan’.
Musharaka
Musharaka or ‘partnership’ means you and your Sharia compliant bank or financial institution purchase the property together under the intent that you will gradually buy the institution out of it.
For example, say you were to have a 20% deposit of the total purchase price, your bank or institution might pay the remaining 80%. After which, you will pay rent to your bank on its 80% share while you continuously buy small portions of the property. The more of the property you own, the less rent you pay to the bank. Eventually, at the end of your loan term, you will own the property outright.
Murabaha
A Murabaha plan is where the bank will buy the property you desire and immediately agree to sell it on to you, for a profit, in instalments. By purchasing the property, the bank is considered to be working under Sharia law.
Murabaha differs from a traditional home loan agreement as the final repayment amount is pre-agreed between the parties, creating a greater degree of transparency.
Under a traditional loan agreement, the cumulative amount ultimately being repaid is unknown, as the interest portion of a person’s repayments could vary over the life of their loan due to refinancing or interest rate fluctuations.
Wakala
Under Wakala, an agreement is made with the bank that they will work as your agent, in a similar way that a buyer’s advocate might.Islamic home loan eligibility
Applying for an Islamic home loan is similar to applying for just about any other mortgage product. Though, as we’ve discussed above, the terms in which you receive your home loan will likely vary in accordance with Sharia law.
Essentially, Islamic home loan applicants will need to substantiate their income in order to demonstrate their serviceability capacity and provide proof of their intended deposit.
A bank will also assess a person’s credit history, employment details, expenses, liabilities, and the details of their desired property to determine their ability to service a home loan.
It’s important to note that being of Islamic faith is not a requirement of those applying for an Islamic home loan.
Pros and cons of Islamic home loans
Pros
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Sharia law compliant - This method of home loans better align with Sharia law to offer those of Islamic faith a means of pursuing home ownership.
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Features - In most cases you are offered the same features as a typical home loan.
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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.
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Covered by the National Consumer Credit Protection Act - This means all Islamic loans are covered by obligations for responsible lending, including assessing whether a credit product or credit limit increase is unsuitable.
Cons
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Limitations in choice - May be limited by a smaller number of loan providers and offerings in order to meet Sharia law requirements.
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Expensive - The unique circumstances surrounding an Islamic home loan and the limited size of the market can make banks charge more in order to gain a greater profit share compared to a typical home loan.
Which banks offer Islamic home loans?
Some of Australia’s biggest banks offer Sharia-compliant finance products. For instance, NAB offers specialised business Islamic finance, which can fund the purchase of commercial property and land worth over $5 million.
In exciting news, Islamic Bank Australia was the first Islamic bank to receive a restricted authorised deposit-taking institution (ADI) licence from the Australian Prudential Regulation Authority (APRA) in 2022.
The bank describes its restricted licence as “like training wheels on a bike”, allowing it to check its systems and processes are in order before its restricted ADI authorisation period ends within two years of being granted. The bank plans to offer Sharia-compliant home financing once it gets its unrestricted ADI licence.
According to the Australian Federation of Islamic Councils, as of 2021, other providers of Islamic home financing include Ijarah Finance, MCCA, Hejaz, Amanah Finance, and ICFAL.
