Islamic Home Loans

Islamic home loans are a fully Sharia-compliant way to own a home. Here’s how they work and why they’re different.

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, updated on August 8th, 2023       

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Australia is lucky enough to have a growing, vibrant Islamic community and Savvy partners with several lenders who offer fully Sharia-compliant home loans to meet increasing demand. Islamic finance might be relatively new to Australia, but it’s an important part of the Islamic belief system and has existed for as long as the religion itself.

Islamic home loans are designed to be as cost-effective, transparent, and practical as any other form of finance, and you can compare the cost of Islamic home loans easily online, just like with traditional Australian mortgages.

What are Islamic home loans?

An Islamic mortgage or home loan is a specialised financial product that’s designed to be compatible with the beliefs of the Islamic community. In essence, Islamic home loans afford homebuyers everything that traditional Australian mortgages do, but they adhere strictly to Sharia law.

Just like with an Australian mortgage, homebuyers make a monthly repayment. The financier also makes some money from providing the home loan, but they don’t charge any interest. As the home loan term progresses, both Islamic and non-Islamic buyers gain equity in their property until the loan gets fully repaid.

Some homebuyers mistakenly think Islamic home loans in Australia just make a superficial effort to comply with Islamic law, but that couldn’t be further from the truth. Often, that’s because they see Sharia-compliant products displayed with an interest rate. Sharia-compliant financiers are bound by Australian regulations to show products in this way. The Australian Securities and Investment Commission (ASIC) demands all financial products be easily comparable, so charges for Islamic home loans get converted to the equivalent of an interest percentage rate for illustrative purposes only.

Conventional western banking practices don’t automatically fall in line with the principles of Sharia law, so Islamic home loans have been designed specifically to provide some common ground. The fact is, a transaction is a transaction no matter which part of the world it takes place, and that makes it possible to construct a compliant product that adheres to the following Sharia values:

Ribā means that both receiving and paying interest is forbidden. While western mortgages use interest as the primary basis for lenders to make money, Islamic home loans work differently. They operate more like a rent-to-buy agreement, and no interest ever gets charged or paid.

Musharakah relates to the sharing of profit and loss. Islamic borrowers and home loan providers both contribute to the cost of a home and profit or loss based on how it performs within the wider property market. That also helps satisfy Gharār, because they’re also sharing transactional risk.

Gharār is an important Sharia principle that relates to uncertainty. That means risk is potentially problematic under Sharia law. While there’s a certain amount of risk with any financial transaction or investment, great care has been taken to design home loans for Islamic customers so they’re structured around a clearly defined contract to make the activity 100% compliant.

Musharakah Mutanaqisah works almost exactly along the same lines as a western mortgage, in that both types of homebuyers gain equity as they repay. It relates to a ‘diminishing partnership.’ That means western-style borrowers owe less, own more, and pay less interest as a home loan progresses. With Islamic mortgages, homebuyers also owe less, own more, but need to pay less rental as the term progresses. The diminishing partnership means they’re gradually buying the financier’s share out as they repay. As they buy more, they pay less to rent the financier’s remaining share until eventually, they own the property in full.

How exactly do Islamic home loans work differently from traditional mortgages?

As you can see, Islamic home loans differ from conventional Australian mortgages in more than mere terminology. They’re invaluable and necessary for Muslim homebuyers because they were designed from the ground up to provide an alternative to mortgages that respect Sharia law and the Islamic belief system.

Although there is no interest component to Islamic home loans and mortgage interest rates do not apply, the buyer and financier enter into a joint agreement to buy property, and the financier is entitled to some profit for providing access to funds. In return, the homebuyer also gets sole use of the property while the agreement is in place – just as users of traditional Australian mortgages do.

With a mortgage, the homebuyer owns the property right from the beginning of the term. Islamic home loans work differently in that the lender owns a percentage of the property too. At the start of the loan, that’s dictated by the size of the deposit that the homebuyer provides. You could say that the primary difference between a traditional Australian mortgage product and Islamic home loans is that with the former, the lender charges interest for providing a sum of money. However, with the latter, the financier charges for providing their share of sole occupancy of the property.

Traditional Mortgage Islamic Home Loan
Homebuyers agree to borrow a set sum of money from a mortgage lender. They will repay the money they borrow over a fixed period along with interest.
Homebuyers agree to enter an agreement with a finance company where each party will have part ownership of a property until the loan is repaid in full.
The lender settles a loan for the value of the home, less the homebuyer’s deposit amount. Then, the homebuyer pays for the property using the borrowed funds and takes sole ownership of the property.
Both the homebuyer and the finance provider take part ownership of the property. Their respective shares are determined by how much deposit the homebuyer supplies.
During the mortgage term (usually between twenty-five and thirty years), the homebuyer makes regular repayments to the mortgage provider. Each one is usually made up of a part of the borrowed amount plus a portion of interest.
During the Islamic home loan term, things work slightly differently. The homebuyer still makes regular repayments to the finance provider, but part is a pre-agreed fee for the property’s sole use during the loan term.
As the mortgage term progresses, the homebuyer gains more and more equity in the property and owes less interest. At the end of the mortgage, the homebuyer owns 100% of their home, and the lender’s involvement is over.
During the Islamic loan term, the homebuyer continues to repay the borrowed amount and gains more and more equity in the property. They also continue to pay for the sole use of the home until they’ve repaid the loan and they own the property in full.

Got some questions about Islamic home loans?

How long does it take to arrange an Islamic home loan?

Sharia – compliant loans take roughly the same time to arrange as western-style mortgages. That can involve valuations and a detailed examination of your personal financial circumstances so it’s a good idea to allow a few weeks. Depending on how straightforward your situation is, it might be slightly quicker or take a little longer.

Are Islamic home loans more expensive?

Just like with all mortgages and financial products, it’s essential to compare Islamic home loans. That’s because the total cost depends very much on lender fees and how much they charge for borrowing – whether that’s through an interest rate, a rental payment, or a profit fee.

What happens if the value of the property increases during an Islamic home loan?

Islamic home loans work just like traditional mortgages in many ways. If property prices rise during the term, you’ll benefit from that equity, not the lender. Islamic home loan providers only purchase your property for the purpose of renting it back to you during the term, not to gain capital from its value.

How much deposit do I need for Islamic home loans?

Generally Islamic home loan with require you to contribute a 20% deposit.

Can I access a grant with a Sharia-compliant home loan?

If you’re a first-time buyer, you can still access the First Home Owners Grant in your state when you use an Islamic home loan.

Why should I compare Islamic home loans?

Different lenders will charge various amounts in rental fees, but they might also charge extra components like setup and monthly or annual account fees, too. That’s one reason why ASIC insists Sharia-compliant financiers display their charges like an interest rate. Just like with comparison rates for interest-based mortgages that allow borrowers to quickly and easily compare the equivalent total cost of all offers out there, no matter how much each individual component costs.

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