What are the principles behind Islamic personal finance?

Islam is not only a religion; it is also a code of ethics that deals with political, social and economic matters. Under this umbrella comes finance, which means that Islamic banking must adhere to the principles of Sharia law.

Islamic lenders are forbidden from earning interest, or riba, on a loan. This is because it is forbidden to make money from money. However, Islamic banks need to make a profit just as much as a conventional bank does; this means Islamic personal finance products need to be approached in a different way.

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 explainedWe also have a guide to Islamic finance for SMEs.

How do Islamic personal loans work then?

Because banks can benefit from buying and selling approved goods and services, Islamic financial institutions can use a number of concepts to facilitate a sharia-compliant loan.

Using the Murabaha concept, for example, the bank purchases goods a customer wants such as furniture, electronics or luxury items and then sells them to the customer at a profit. The profit is added to the customer’s monthly instalments and is referred to as a profit rate, replacing the conventional interest rate.

Another approach banks use for customers who simply want cash to pay off debts or to go on holiday is to buy commodities or stocks and then, once again, sell them back to the client at a profit. The bank will buy the commodities or stocks and then an independent broker will sell them, releasing the cash back to the customer.

Alternatively, the bank may turn to the concept of Ijarah, a leasing agreement, to buy a service on a customer’s behalf such as a medical procedure, a wedding or their annual rent and then lease that service back to them.

These different methods of facilitating a loan means that Muslim consumers can sign up for a personal loan product, similar to a conventional loan, safe in the knowledge they are doing so in accordance with Islam.

What happens if I miss a payment?

Because the loan is sharia-compliant, banks cannot charge interest on that missed payment. Instead they will encourage you to make the payment as quickly as possible. They may also charge a fixed fee and, like any financial institution, can take further steps if a customer persistently defaults on the loan.

Can a non-Muslim sign up for Islamic personal finance?

Absolutely. Anyone can take advantage of Islamic banking products as long as they meet the bank’s requirements for that particular product. In fact, many non-Muslims may have signed up for Islamic personal finance unwittingly as bank sales agents target all sectors of the community, regardless of their religion.

How do I find the best Islamic personal loan to suit my needs?

Your first job is to compare all Islamic personal finance products in the UAE or compare all Islamic personal finance products in Saudi Arabia. Factors to consider include the profit rate, minimum salary required to qualify and any upfront or early settlement fees charged.

It’s also wise to remember you will get a better rate on your loan if your salary transfers into the bank you are borrowing from.