REAL ESTATE AGENCY PRACTICE II (REA 252)

INDIVIDUAL ASSIGNMENT

WHY ISLAMIC PROPERTY FINANCING IS A

BETTER ALTERNATIVE FOR CONVENTIONAL
PROPERTY FINANCING

FACULTY : FSPU
GROUP : AP1154F
PROJECT TITLE : WHY ISLAMIC PROPERTY FINANCING IS A BETTER

ALTERNATIVE FOR CONVENTIONAL PROPERTY

FINANCING
PREPARED BY : ABU ASYAD BIN ABDUL HALIM (2018229708)
PREPARED FOR : DR HILMI MASRI

SUBMISSION DATE: 14.06.2020

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 ACKNOWLEDGEMENT
First and foremost, Alhamdulillah and thanks to Allah, with his blessing, I able to achieve
the success of finishing this assignment. I also would like to seize this opportunity to thank my
lecturer Dr Hilmi Masri for all guidance during our journey of completing this Business Model
Canvas. During this unprecedented time of global pandemic due to COVID-19, Dr Hilmi has
shown a great effort to continue his lecture.

Not to forget, much appreciation given to my beloved parents, who always giving their
support in my assigned task. Their support is the reason why I am giving my best effort during
the process completing this assignment. I also want to thank my fellow classmates of AP1154F
for their help that has facilitated me to finish this task. It is always a motivation to have friends
who are competitive in a good way.

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 TABLE OF CONTENT
NO CONTENT PAGE
1.0 INTRODUCTION 3
2.0 ISLAMIC FINANCING 4
2.1 Introduction of Islamic Finance 4
2.2 Element of Islamic Finance 5
2.3 Advantages and Disadvantages of Islamic Finance 6

3.0 CONVENTIONAL FINANCE 8

3.1 Overview of Conventional Finance 9
3.2 Advantages and Disadvantages of Conventional Finance 10
4.0 COMPARISON: WHICH IS BETTER 11
5.0 CONCLUSION 12
6.0 REFERENCES 13

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1.0 INTRODUCTION

Finance in general is the study of the process, institution, market, and instruments used to
transfer money and credit between individuals, business, and government. It is also a broad term
that encompasses activities regarding banking, leverage or debt, credit, capital markets, money,
and investments.

Demand for homeownership is gradually increasing on par with the growing population
of people in Malaysia. Everyone dreams to own a home, but the housing loan taken by Malaysia
household has made up around 45% of the total household debt. This situation implies that
purchasing a house is the single, most cost and huge decision to undertake by any household.
Deciding to go for which best mortgage provider is even more complicated for potential house
buyers as mortgage market is flooded by plenty options of mortgage schemes.

Malaysians have number of choices when it comes to getting a loan. As with any
financial products, the most crucial thing is to compare the various products available in the
market and between different financial institutions. This will help ensure that the homebuyers
will choose the right one based on their needs and requirements.

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2.0 ISLAMIC FINANCING

2.1 Introduction

Islamic financing, or specifically Islamic property financing, in Malaysia is claimed to be

one of the most advance and established in the world. Islamic banking which complies with
Shariah laws has been used since the enactment of the Islamic Banking Act in 1983 and the
establishment of Bank Islam Malaysia Bhd, also on the same year. After few decades of
continuous development, Islamic financing have evolved to be on the same par and just as
competitive as the conventional financing.

Malaysia has one of the most advanced Islamic Finance industries globally. Since
introduction, Malaysia has always been at the top of Shariah-compliant financial products and is
witnessing a development in Shariah or Islamic home loans. The key behind this rapid growth is
this country is populated by the Muslim as the majority. The element of interest is strictly
prohibited under Shariah Law, so the practicing Muslims prevent themselves from doing
conventional financing that is interest-based. However, through Islamic financing, Muslim
homebuyers are offered with a better alternative that adhere to their belief.

Islamic financing which bind to Islamic Shariah principles strictly prohibits the
involvement of haram, riba, gharar and zulm. Haram includes the business of alcohol and
gambling. Riba is defined as the practice of lending at a high rate of interest. Gharar means the
speculative or risky sales where the value is dubious while Zulm, are exploitative or oppressive
activities and practices.

However, there are no religious requirement or restrictions in applying for Islamic

financing. Simply put, both Muslims and non-Muslims homebuyers are welcome to choose the
Islamic finance option for their mortgage scheme. In fact, there has been a gradually increment
of non-Muslims homebuyer’s application for Islamic financing scheme.

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2.2 Types of Islamic Finance

Islamic financing was introduced as the alternative for the interest-based conventional
financing, because Shariah Law forbid the computation of profit from interest. There are several
ways to ensure the financial institution can still gain profits, even in the manner of complying the
Shariah Law. The Murabahah concept in Islamic financing is the simplest method for the bank
to eliminate the interest which is by purchasing the house for the borrower and sell it to them at a
higher price. Profit for the bank is gained by the marked-up amount less from the initial cost of
purchasing the property.

Banks that provide Islamic financing scheme essentially follow two types of Islamic
financing principles which are Bai Bithaman Ajil (BBA) and Musharakah Mutanaqisah (MM).
BBA is adapted from the Murabahah concept and is the most popular option for home buyers
seeking for Islamic financing. MM is a concept of forming partnership between the bank and the
borrower in order to buy the property. It is a recent option that have advantages as well as
drawbacks of this partnership.

Islamic home loans scheme in Malaysia, which follow the Bai Bithamin Ajil (BBA)
concept, the borrower will co-own the property with the bank, and they will buy back the bank’s
share of the property through monthly repayments to. A sale contract of BBA is made where the
bank sells back the property to the borrower with payment made on cash terms or deferred
payments such as monthly instalments. The property will be transferred over as a gift, also
known as Hibah, to the customer once they have made the final payment.

Musharakah Mutanaqisah (MM) is based on a partnership concept. In a home financing

that adapt the principle of MM, the customer and the bank jointly buy and own the property.
Then, the bank will lease its share of the property to the borrower in an agreed rental amount that
includes principal repayment and profit component. In return, the borrower promises the bank
under an agreement, to buy the bank’s ownership of the property. The borrower will make
progressive payments of rental to the bank until they acquire full ownership. A specific amount
from the rental payment is used to progressively decrease the shareholding by purchasing the
bank’s share of the property.

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2.3 Advantages and Disadvantages of Islamic Finance
Other than providing greater social and moral responsibility and fairness, Islamic
property financing offers numerous advantages to the borrower.

Cost of stamp duty is reduced by 20% through Islamic financing. It is implemented by

the government in Budget 2007, as one of the initiatives to promote Islamic financing. This
valuable and less-consuming stamp duty discount for Islamic loan agreement documents is still
valid as part of the government action to attract more people applying for Islamic financing. Not
only that, stamp duty is waived for the redeemed amount when customers refinance their loan
from a conventional loan scheme to an Islamic scheme.

Next, the are no penalty fees imposed for early property disposal and there is no lock-in
period. As the Shariah Law promotes the principle of fairness, the borrower has the freedom to
exit anytime without be given any penalty if they have fairly settled their outstanding
obligations. In fact, the borrowers will receive Ibra or better know as rebate from some Islamic
banks when they make early settlement on their Islamic home financing.

In Islamic financing, late repayments should incur lower penalties. Bank may charge
penalty fees on late payment of the financing, but the charge is not more than 1% per annum on
the overdue installments and it is not compounded. According to the Guidelines for Late
Payment Charges for Islamic Banking Institutions that have been effective 2012, the penalty is
based on ta’wid which refers to the amount that may be compensated to the bank based on the
actual loss incurred due to late payment.

Lastly, Islamic financing provide the borrower with ceiling rate price protection. Islamic
loans are based on Base Financing Rate (BFR) and the profit rate is floating. It is not fixed which
the bank can adjust over the duration of the loan, based on prevailing market conditions.
However, this floating profit rate would never go higher than the ceiling rate, which is the
maximum profit an Islamic finance provider will earn. This will serve the borrower price
protection against high fluctuations of the benchmark rates.

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 Despite having many advantages, Islamic financing does have its drawbacks too. These
includes additional costs during loan restructuring. This happens because a new Sale and Buy-
back agreement needs to be created and signed if there are any alteration. For instance, when the
borrower wants or need to modify their loan terms, they would have to spend more money for a
new loan agreement.

There are more legal documents involved for Islamic banking in Malaysia, so a
significantly higher legal fees may be incurred by the borrower.

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3.0 CONVENTIONAL FINANCING

3.1 Overview of Conventional Financing

Conventional financing accounts for a large majority of the total housing loans in the
market. In conventional housing loans, the bank lends borrowers money with an interest to buy a
property. Banks then earn their profit from the interest charged on the amount borrowed or in
this case, the price of the property. When the borrower takes out a conventional housing loan,
they agree to repay the loan amount, along with the interest rate and the prescribed rate over a set
tenure by installment. The specified rate is based on a margin above the bank’s base lending rate
(BLR).

Almost every conventional property loan in Malaysia are variable interest rate loans, with
the interest rate tied to the base lending rate (BLR) of banks. The banks usually charge either
fixed or not fixed, variable interest rate that increase and decrease on conventional loans or even
sometimes it might be the combination of both.

Conventional home loans can be categorized as flexi, semi flexi or non flexi loans. Flexi
features which named after the ability to make additional payments over the monthly instalment,
will give greater flexibility to the borrower. In flexi loan, borrower is provided with the option to
redraw or make extra repayments at any time without having to inform the bank beforehand. For
semi flexi loan, it is more flexible compared to the initial basic term loan, and the borrower is
qualified to dump into their home loan’s deposit portion if they have extra saving, to reduce their
loan interest Lastly, full-flexi loan share the same characteristics with semi-flexi loan but what
distinguish them is, the borrower can redraw their advance payments without being charged with
no extra fees or penalty.

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3.2 Advantages and Disadvantages of Conventional Financing

Being the most mainstream option for property finance, conventional financing has their
own advantages that attracted many homebuyers.

The most obvious advantage of the conventional property financing scheme is it does not
operate on the basis of Shariah law. It is considerably more open and transparent because any
works or transactions are allowed if it does not contradict with the law of the country.
Conventional home loans are known to be more transparent as extra charges for any default by
the borrower such as late payments, are clearly stated in the signed contracts.

Next, conventional financing allows the borrower to restructure or refinance their loan
easier. Any alterations to the terms of the finance would just need to be up stamped by the Loan
Facility Agreement. For instance, if the borrower wishes to increase the loan amount on a
property, there would only be an additional stamping fee charged, without having to set up a new
agreement. In a conventional mortgage, this could lead to more savings if such a situation were
to arise.

However, there are always two sides of every coin and here are the disadvantage side of
conventional financing.

If the borrower takes out a conventional property financing scheme, they must
acknowledge that the floating interest rates on the loan does not have a maximum cap. Despite
receiving prior notification and justification when the bank adjusts its base rates, it could
potentially increase to an alarming rate without having a cap. This would cause the homeowner
to have very high monthly commitments and inviting difficulties to long-term financial budget.

The bank also has the power to charge additional interests to the borrowed amount, if the
borrower happens to make a late payment or any other defaults, The interest compounded is a
method of paying extra fees when the borrower cause any defaults by late monthly payments.
Not only that, the payable interest may be capitalized which means an interest charge is added to
the total amount of interest owed since the last payment of the balance.

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4.0 COMPARISON: WHICH IS BETTER

Having many options of property financing, it is crucial for Malaysian homebuyers to

distinguish the differences between each financing schemes. Although many people claimed that
there are no significance differences between these financing options, it is important to highlight
that there are certain features that makes Islamic property financing a better alternative for
conventional property finance.

In conventional financing, the bank charges interest on the loan which requires the
borrower to repay the loan along with the interest. However, Islamic banking considers interest
as riba, which is prohibited to Muslims. This create difficulties to Muslim homebuyers which
form the majority in Malaysia, to own a property in a manner that complies to their belief. This is
where Islamic property financing comes into action to help by introducing the concept of
murabahah, where the bank buys the property and sells it back to the customer with a marked-up
price. The borrower will buy the house on the marked-up price via monthly installments and the
margin of the price is how the bank gain profits.

Next, in the context of risk, Islamic financing provide the borrower with ceiling rate price
protection. The floating profit rate would never go higher than the ceiling rate, which is the
capped at the maximum profit an Islamic finance provider will earn. Meanwhile, floating interest
rates on the conventional loan does not have a maximum cap, which will expose the borrowers to
additional monthly installments of the loan. Conversely, Islamic property financing is proven to
be better in this context as they will serve the borrower with protection against high fluctuations
of the benchmark rates.

Compared to the conventional property financing, the penalty fee for late repayment of
Islamic property loan is significantly lower. If default, the borrower only charged with not more
than 1% per annum on the overdue installments and it is not compounded. In contrast, the
conventional financing obliged their borrowers to pay extra fees when the borrower causes any
defaults by late monthly payments. This disadvantage is not stopped there as the payable interest
may be capitalized. This scenario will never occur in Islamic property financing.

These features are few of many more advantages of Islamic property financing that
makes it a better alternative for conventional property financing.

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5.0 CONCLUSION

Islamic financing has proven to be a better alternative for conventional financing as it has
more advantages in wide range of aspects. However, it is a surprise that Islamic financing is still
not a popular option for many homebuyers. This is likely to happen because the homebuyers are
unaware of this better option. An immediate and proactive actions should be done to ensure the
Islamic financing will have better levels of adoption in Malaysia homebuyers.

Government should play a more active role in the introduction of Islamic financing. A
clearer and uniform guideline is needed to unlock the potential of Islamic financing becoming
the first option in property financing, throughout the nation. A further extension of the tax
incentives such as the stamp duty discount will help increasing the demand for Islamic financing
scheme from the homebuyers who in need of savings.

Malaysia’s central bank, Bank Negara Malaysia, should roll out a plan to standardize
Islamic financing scheme. This will ensure all banks that offer Islamic financing scheme will
adhere to the highest Shariah standards in the documentation, system, or implementation in
general. Although almost all banks in Malaysia already providing Islamic property financing
scheme, they should work out the advertising and promotion on a larger scale.

Estate agents also can help their homebuyer clients by giving them advice on how to
choose the best property financing scheme, among others. As estate agents already gathers
important documentation of their client such as income, asset, and credit reports, they should
recommend Islamic financing if the clients are eligible. There are certain features in an Islamic
property financing scheme structure that gives benefits that appeal to certain types of customers,
based on their needs and requirements.

On the other side, there are also homebuyers that need other features which is not
available in Islamic financing. This explains the importance of why deep understanding in
property financing should be ensured, before taking out a loan. There are major variances
between Islamic and conventional financing that are worth taking into consideration.

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6.0 REFERENCES
i) Khir, K., Gupta, L., & Shanmugam, B. (2007). Islamic Banking: A Practical
Perspective. Petaling Jaya: Pearson Longman.

ii) Rosly, S. A. (1999). Al-Bay’ Bithaman Ajil financing: impacts on Islamic banking
performance. Thunderbird International Business Review, 41(4/5), 461-480.

iii) Yusof, R. M., Kassim. S. H., Majid, M. S. A., & Hamid, Z. (2011). Determining the
viability of rental price to benchmark Islamic home financing products: Evidence from
Malaysia. Benchmarking: An International Journal, 18 (1), 69- 85

iv) Razak, D. A., & Taib, F. M. (2011). Consumers’ perception on Islamic home
financing: Empirical evidence on Bai Bithaman Ajil (BBA) and diminishing partnership
(DP) modes of financing in Malaysia, Journal of Islamic Marketing, 2(2), 165-176.

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