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What is the difference between conventional financing and Islamic financing?

When asked about the difference between these two types of financing, the general answer is that both are the same, except in a conventional loan, the purchaser will pay interest, and in Islamic financing, the purchaser will pay a profit.

In a conventional loan, the customer will repay to the bank the loan amount, together with interest at the prescribed rate. The prescribed rate is based on a margin above the bank's base lending rate (BLR), and both the margin and the BLR are variable from time to time. In a case of late payment or default, the bank is entitled to charge compound interests. Interest payable may also be capitalised and the capitalised amount will be subject to further interests.

A common home Islamic financing facility is offered under the Shariah principle of Al-Bai Baithaman Ajil (BBA). In BBA financing, a bank's customer buys a property from the vendor under an agreement of sale. The bank then, at the request of the customer and with the consent of the vendor, steps in to become a party to the sale agreement by executing a novation agreement between them, making the bank now the purchaser of the property. The bank's purchase price is described as the loan facility amount.

At the same time, between the bank and the purchaser, the bank sells the property to the customer at a selling price which comprises the bank's purchase price and a predetermined profit margin. The agreement is usually called the property sale agreement. Since Islamic financing entails a predetermined profit to be made by the bank, a customer will never have to worry about a sudden hike or changes in the interest rates. Right from the onset, he will know the total amount which he has to pay to the bank. His monthly instalment of the bank's selling price will not change throughout the tenure of the financing.


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