Many people have Islamic car finance without realizing it – but what is the difference between Islamic and conventional vehicle finance and how does that affect the consumer?
This is one of a series of six guides to Islamic products: Islamic Banking – how does it work? | Islamic bank accounts explained | Islamic credit cards explained | Islamic personal finance explained | Islamic car finance explained | Islamic home finance explained. We also have a guide to Islamic finance for SMEs.
Why is Islamic car finance necessary?
Islamic banking strives to adhere to Islamic law and central is the fact that money has no intrinsic value; it is simply a medium of exchange. Therefore profit cannot be made from exchanging money with another person, meaning that a Muslim cannot benefit from either lending or receiving money. This is why a different approach is needed for personal finance products such as car finance.
So how does an Islamic car finance
One of the main principles of Islamic finance is that earning interest, or riba, is forbidden. So by using the concept of Ijarah, a leasing agreement, the bank buys an asset for a customer, such as a car, and then leases it back to the customer with a fee attached over a specific time period.
It allows Muslims to enjoy the same access to buying a new car as anyone else, all the time ensuring they are doing so in a Sharia-compliant manner. Once the lease period (or tenure) is complete, the customer gains ownership of the car.
Banks may also adopt other concepts such as Murabaha, a similar arrangement to Ijarah, where the bank buys a car on behalf of a customer and resells it to them, clearly mentioning the cost incurred in buying the product and the mark-up when reselling the car to the client. This may also mean your agreement limits you from taking the car outside of the country, as it is owned by the bank and not you.
Is this why I am charged a profit rate rather than an interest rate?
Absolutely. The bank needs to make money out of the arrangement but because interest is forbidden, it charges a profit rate instead on the lease or resale of the car to you.
What happens if I default on a car payment?
Well, under an Islamic contract, the bank cannot charge compound interest if a customer defaults or misses a payment. However, they may charge a fixed fee – a portion of which may be donated to charity to ensure the fee remains Sharia-compliant. If the missed payments continue,as the technical owner of the car, the bank can demand the car is returned so that it can sell the vehicle to recoup any losses.
Can I sign up for Islamic car finance if I am not Muslim?
Absolutely. Islamic car finance is available to everyone as long as they meet the bank’s requirements for the finance. In fact, a lot of people may have an Islamic car finance product without even realizing it. If they had compared all the car financing available at the time of the purchase, they may have signed up for Islamic vehicle finance simply because it was the best deal. Not all consumers realize there is a difference.
Is Islamic car finance only available for new cars?
Not at all. Like conventional car finance, Islamic vehicle finance is available for both new and secondhand vehicles.
How do I find the best Islamic car finance?
Like all finance, make sure you do your homework and compare all the Islamic car finance available. In the UAE, as per Central Bank guidelines, financing typically require a 20 percent deposit with a maximum repayment period of five years. However some finance require zero percent deposit, as the bank pays that for you and then adds it to your finance amount. [Compare Islamic car finance in the UAE | Compare Islamic car finance in Saudi Arabia]
Firstly, decide how much you want to borrow and the length of the finance period before you begin your search. Then remember to watch out fees, such as early settlement and upfront fees – both typically one percent – and note you will get a better profit rate and finance amount if your salary transfers into the bank.
Finally, look out for any added extras such as free car insurance with the finance, extended warranties or free traffic registration.