Fact or Myth? Islamic Finance is More Expensive than Conventional Home Loans
Understanding the Differences Between Islamic Finance vs. Conventional Loan
There is a belief that Islamic finance is more expensive than conventional home loans. In the past, this once held true; however, it has been relegated to a myth in recent years as Islamic financing has become relatively cheaper. Islamic home financing is now competitively priced to a traditional mortgage.
Many home buyers just don’t understand or know enough about Islamic finance to reach such a conclusion. Here are some key points that highlight the cost-effective nature of Islamic home finance and disprove the myth that it is more expensive than conventional home loans.
What is an Islamic mortgage?
First, it is important to understand the terminology. An “Islamic mortgage” is not actually a mortgage at all. A home may be financed in several ways under Islamic law. The most popular model of Islamic home finance in America is a form of co-ownership, in which the home buyer and the financing company agree to invest in a property and buy a home together. The home buyer gradually buys out the financier’s stake in the property, while paying a fee to use the part of the property still owned by the financier. Unlike a traditional mortgage, this is an asset-backed transaction.
What is a conventional loan?
A traditional mortgage involves essentially buying money for more money. A bank or other lender has nothing to do with the home itself, so there is no asset involved. Instead, the financier allows the homeowner to use a certain amount of money in return for a promise to pay interest (in other words, more money) later. This model creates an uneven and unequal relationship, in which the lender holds all of the power and profits from the buyer’s needs.
Fact: Interest is Avoided in Islamic Finance
Islamic financing prohibits riba or interest. In Shariah-compliant home financing, the home buyer does not pay riba or interest to the finance company as he or she does when financing with a conventional home loan. Thus, in the event of a default, Shariah-compliant home financing agreements protect the buyer from having to pay compounded interest that results in a price greater than the original sale price of the house.
Fact: Conventional Loans Have More Financial Risks
Conventional loans place all of the risk on the home buyer. If you can no longer pay and your home goes into foreclosure, you are responsible for the full cost of the home plus many more fees. Similarly, in the case of a natural disaster or eminent domain (which is when the government seizes part or all of a property for public use), losses are yours to bear alone. In contrast, under Guidance Residential’s co-ownership program, the risks are shared.
Islamic Finance Does Not Compound Fees
Islamic financing does not compound late payment or prepayment fees. Islamic finance providers aim to keep the entire home financing process Shariah-compliant, and therefore, will not compound late payment fees like conventional home loan providers sometimes do. Instead, Islamic financiers charge a fixed fee that covers the late payment fee expense and does not serve as a means for profit. Additionally, conventional home loan providers sometimes charge a prepayment penalty to buyers who want to pay ahead of the agreed timelines, while Islamic finance providers do not.
Minimizing Financial Risk with Islamic Home Financing
Islamic financing shares the risk with the buyer. One of the unique components of Islamic finance is the co-owner or partnership program. Islamic financing providers share the risks with the buyer since they act as a co-owner or partner. In the case of a foreclosure, for example, Islamic financing providers do not receive more than the sale price of the house, whereas the lender in a traditional mortgage will expect to be paid in full regardless of the price the home ultimately sells for. Conventional home loan providers also do not share the risk of natural disasters, eminent domain or foreclosure. Through this type of financing, the home buyer bears the brunt if any of these misfortunes occur. Islamic home financing offers greater protection for the homeowner.
Fact: Islamic Home Financing is Competitively Priced
While prices were once higher for Islamic home financing compared to a traditional mortgage, this is no longer the case. As the Islamic home finance industry has grown in the United States, Islamic financiers have been able to offer rates similar to the market rates used for a traditional mortgage, while the foundation of the Islamic contract remains completely different from a loan. This makes it easier for the consumer to compare between the two options.
The end result is that Islamic home finance is now competitively priced compared to conventional home financing. It has become an affordable option for those who wish to achieve homeownership without compromising their beliefs.
The key takeaway is to always do research before moving forward with any home financing provider so that you are prepared to make the best decision that aligns with your values and accomplishes your goals. Take a moment to review Guidance Residential’s home financing rates and contact us to get started today.
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