Shariah-compliant equity-based financing needed for Islamic home loans

Islamic home loan consumers stand to lose out to those using conventional equivalents in the event of a default/early settlement and the adoption of Shariah-compliant equity-based financing could be the solution, said an economist from International Islamic University Malaysia (IIUM).
Due to the structure of the Islamic home financing system, in comparison with the conventional equivalent, consumers of such products were at a disadvantage, said Dr Ahamed Kameel Mydin Meera, an associate professor at IIUM department of business administration, kulliyyah of economics and management sciences.
"It's not the problem of Islamic loan concepts like bai bithaman ajil (BBA) but in the way it's implemented in the present monetary system makes it problematic. If you take Islamic financing, in the case of defaults, you will owe more," he said in presentation at the contemporary issues in Islamic home, personal and auto finance conference in Kuala Lumpur last Friday.
Ahamed Kameel had earlier shown that his calculations indicated that, when compared to standard conventional home financing products, users of Islamic home loans stood to pay much more if they defaulted or settled earlier than the previously agreed upon repayment tenure.
"Early settlements are common. Studies have shown that people move from a home to another home within ten years due to a variety of factors. This will mean that you'd want to sell up the house and move on to another one. Those taking Islamic financing, again, will be at a disadvantage because you will owe more than those taking conventional financing," he said.
As a result of the global financial crisis, more and more people are expected to default on their mortgage.
"If you can get hold of banking statistics, I'm sure you can observe this. The statistics will show that more and more people will default simply because there's less money circulating. This is why we need to have some solutions in place before you see a lot of people out there frustrated by the end of the year," he said.

Speaking to reporters later, Ahamed Kameel posed the question if the defaults in Islamic home financing rise gradually.
"The defaults will be both for Islamic and conventional because of the macro-economic system that is imposing on customers. But the issue is those who default on the Islamic system will tend to owe more. The Islamic system is a safe contract, this means that profit is capitalised upfront.
Even if you pay back, say for a 20 year loan, after ten years, the profit for the remaining ten years is still due.
"But, for conventional, the loan balance is always lower than original loan taken because you don't need to pay interest for the remaining ten years," he said.
Asked whether there were already existing guidelines to protect Islamic home financing consumers, Ahamed Kameel said: "Right now, as you know, there are a few cases in the courts and similar things will happen. That is the reason why we're holding this conference, to come out with proper, standard procedures to solve these kinds of issues.
"How to make Islamic home financing attractive then? You need to make it more equitybased. The musharakah mutanaqisah is a very promising alternative but you have to make it exactly as it is, which means you use a rental rate rather than an interest rate. I believe this is the way to go."

(This story appeared in The Malaysian Reserve on 5 April 2010. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)