Islamic vs conventional home loan 2
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If you are seeking a home/property loan in Malaysia, here are some good news for you. Whether you are a foreigner (living in the country on a long visit visa) or a local/Malaysian resident and no matter what faith you follow, you enjoy the option to choose between Islamic and conventional home financing.

With both, you get the same results - financing for a property as well as the insurance. However, there are differences between the two. Let’s take a look at them in detail.



Conventional Home Loan – How it Works

In conventional financing, the bank will lend you money to buy your property and in return, you will have to pay back the principal the total of your loan together with the interest on that amount.

The payment you make to the bank is by installments over a set tenure and each installment amount is split between paying down the principal and servicing the interest.

This interest is the cost of borrowing the principal amount, this is where the bank makes its profit.

The interest can follow a fixed rate or be based on a floating rate such as Kuala Lumpur Interbank Offered Rate (KLIBOR) or Base Lending Rate (BLR) and the loan contract is known as a Loan Facility Agreement.

Most of the time, you will also have insurance and taxes included in the monthly amount.

How much interest you end up paying will depend on how quickly you repay the principal amount, what the interest rate is and how much it goes up or down, as well as whether you default on the loan or are late with any of the payments.



Islamic Home Loan – How it Works

Here, the concept of buying something on the borrower’s behalf and selling it back to the borrower at profit is used.

Islam does not allow usury (interest or riba), but it allows trading. This is why the bank buys the property on your behalf and re-sells it to you at a profit instead of lending you the money and then charging you interest.

This profit rate can be based on a fixed rate or a floating rate and payments to the bank are made through installments similar to conventional financing.

The majority of Islamic home financing in Malaysia today is based on Bai Bithamin Ajil (BBA) and the loan contract here is called a Sale and Buy-Back Agreement.

BBA works on a Selling Price that is fixed, while a Musyarakah Mutanaqisah (a contract of partnership between two parties), may have a fixed price element built as a maximum cap. Nevertheless, the total amount depends on the reference rate tied to the product (BLR or BFR). There is also Murabaha (sale on deferred payment basis) and Ijara (leasing).



What You Should Know Before You Decide

(i) Islamic home loan is more of a partnership. This means that the bank will share risk with you, such as in the case of an abandoned development. Meanwhile, conventional home loan providers do not share risks such as foreclosure or natural disasters.


(ii) Islamic financing can be more expensive, particularly in cases where you want to increase the facility amount or alter other terms of finance as a new BBA (Sale and Buy-back Agreement). The bank may increase your legal costs as there are more legal documents involved than conventional financing.

Having said that, you can enjoy discounts (such as a 20% discount on stamp duty for Islamic loan agreement documents) if you decide to go with this option.


(iii) The concept of early settlement does not exist in Islamic finance and this means that you may be liable for the future profit rate if you settle early (make sure you are aware of this).


(iv) If you decide to go with conventional financing, you will be subject to floating interest rates which have no cap. Islamic floating profit rates on the other hand, are capped at a maximum. Also, in the case of late payments, conventional hire purchase charges a fee of 8.00% per annum of the due installment, while Islamic financing only charges a late payment fee of 1.00% per annum.


(v) Conventional home loans are known to be more transparent as extra charges for defaults, late payments and other issues are stated more clearly in the conventional contracts.


Read more about loan applying tips here: 5 Home Buying Tips From Malaysia Housing Loan



Conclusion

Now that you know what differentiates Islamic and conventional home loans, it should be easier to identify the key benefits from each and choose the one that suits you best.

There is no hard and fast rule that can help you go for one or the other. The fact is that both the loans are available to everyone and the choice between the two really depends on the deals you are getting from the loans, as well as your personal situation or objectives.

The best thing to do is to examine both options (check with different banks as well) and then choose one that offers you the most suitable margin of finance, interest/profit and what is easier for you to pay back.

Now that you are equipped with more home financing knowledge, its time to start your property search with PropSocial where you can find honest and real property reviews! 



(Written by: Rauf Fadzilla, 12th Dec 2017)


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Generally, does Conventional Home Loan allow early settlement or an additional principle payment to reduce the total interest?

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@domng I think can, but depending on banks, and they have a lock period like maybe 2-3 years you cannot do partial/full settlement of principal amount to reduce the total interest.

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@Zara 

I understand there is a lockin period for full settlement... never knew there is a lockin period for partial settlement of principle amount?

Own dp small

Great info shared. I really do not know much on these. Legal and stamp duty is a heartache when it needs to be given at the starting of the time or in the midst of getting the property

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Conventional or Islamic, I think we can still refinance after the so-called lockin period (if any). We still need to bear in mind the additional legal and stamp duty fees, when we consider to refinance to another mortgage package...

I would suggest to first negotiate with your existing bank, ask nicely and they might just offer you a better deal on loan repayment!

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@admin_ps thanks for sharing