Mortgage

Islamic Mortgage vs Conventional Mortgage Explained

There is a general belief that Islamic mortgages are better than conventional mortgages as there isn’t any interest rate. This is what makes even the non-Muslims interested in this system.

But before you go ahead and apply for Islamic mortgage, here is a bit of insight to help you understand this mortgage and its points of difference from conventional mortgage.

Defining conventional mortgages

In the case of conventional mortgages, financial institutions like banks lend money for buying new homes and they charge a certain interest on that loan. Conventional mortgages are made of the amount borrowed (the principal) and the interest charged.

As with most mortgages, the interest and principal get paid off monthly within twenty-five years, which is the reason why they’re termed as repayment mortgages.

At the start, most of the payments made by a borrower are focused at paying the interest, while a small part goes in reducing that principal amount. When the term end comes near, this process switches such that more amount gets paid off from the actual loan every month.

Defining Islamic mortgages

Islamic home loans work in a different manner as an Islamic financial institution is prohibited to charge interest. A number of Muslim financing models exist, though Ijarah and Murabaha are the key models utilized for home loans.

Understanding Riba free

As per the legal jurisprudence of Islam, lending money to earn profits from an investment activity, such as real estate financing isn’t an acceptable way of commerce. In simple words, interest (or Riba) is completely prohibited.

An obvious cause is that, a loan in Islam is supposed to be a kind of charity – a chance for a person to aid another who is facing a tough situation. The lender can only expect to receive the amount they lend out. Loans aren’t the way to earn money.

Islam also prohibits buying or selling anything that has zero intrinsic value. Loans with interests are basically paying for money using more money. Since money contains zero intrinsic value, it cannot be bought.

Murabaha model of financing

In this case, the bank buys a property on the customer’s behalf and resells that to them again at a profit. The buyer uses monthly installments to pay the money back to the bank.

Muslim banks require collateral for protecting themselves against their buyers failing to make repayments. Thus, the property remains bank-registered until the mortgage payments are fulfilled, though there are a handful of banks that include the name of the tenant on the title deed.

Islamic mortgages have an advantage that borrowers need to pay no additional interests for late payments, although banks might charge fixed fees.

Ijarah model of financing

The Ijarah model of Islamic finance is basically a purchase and lease-back arrangement. The model is helpful when you are purchasing a property off plans because no payments have to be made until a property gets completed.

The endnote

Hopefully, this clears up the differences between Islamic mortgages and conventional mortgages. You now have the basic idea to decide which path to choose.

Anju Karmyani