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When it comes to buying a car, most people need financing. Auto loans (those issued directly by the dealer) typically have lower interest rates than bank loans because the car is used as collateral – meaning if you miss payments, the dealership can take the car.
But what if you don’t want to deal with interest at all? Luckily the world of Islamic finance has a growing number of halal car financing options. In this post we’ll break down the ways you can buy a car without compromising your Islamic ethics.
Read more about: Islamic Finance Vs. Conventional Finance, What is the difference?
The most popular sharia-compliant car financing involves what’s known as Murabaha, a cost-plus financing model that’s offered by many Islamic banks.
In this case, the bank buys the car from the dealership on your behalf and then sells it to you with a markup (the cost plus an agreed upon profit margin). You pay the bank back in fixed installments over an agreed period and avoid riba (interest).
Transparency - Unlike auto loans, which often involve less-than-obvious payment terms, the cost of murabaha is clearly disclosed at the outset, making it a more transparent option. And installments are fixed, so you can budget.
Ownership - You own the car on day one. That’s because the bank is actually acting as a seller and not a lender. With a conventional loan it’s just the opposite: the bank is acting as a lender and has a legal right over the car until you have repaid the loan in full.
Pro-tip: Shop around at different Islamic banks for a better deal. Some banks may ask for a higher profit margin than others.
And more and more traditional banks offer Islamic banking services. You may be able to negotiate the profit margin and repayment period. You’ll likely have to provide proof of income. A good credit score can help.
Read more: Your Basic Guide To Commodity Murabaha
If you’re not sure you want to outright buy a car, you can opt for Ijarah, a sharia-compliant style of leasing that offers you the type of flexibility that traditional leasing gives you, while avoiding riba (interest payments) and gharar (excessive uncertainty).
Similar to murabaha, with Ijarah you make a deal with the bank on a specified lease period and monthly payments that include a profit margin for the bank.
Then, the bank buys the car on your behalf. Unlike murabaha, the bank owns the car during the leasing period. At the end of the leasing period, you can return the car and stop making payments, renew the lease, or purchase the car at a pre-agreed price.
Read more about: Gharar: What exactly is it and how to avoid it?
Lower payments - With Ijarah, monthly payments are usually lower than what you would pay with murabaha or a traditional loan. That can help you save cash for other needs.
Flexibility - Whether you prefer driving a new car every few years or just aren’t sure you want to own this particular car for a longer period, this halal leasing model gives you more options.
Pro tip: Leasing often comes with fees for things like excess mileage or excessive wear and tear. Read the contract carefully and add this to your calculations when assessing the total cost.
Read more about: How Ijarah Differs From Conventional Leasing
In Arabic, the work “Musharakah” means “partnership.” In Islamic finance specifically, Musharakah implies entering into a joint ownership agreement with the bank, in this case for the purchase of a car.
As you make payments, you gradually buy out the bank’s stake in the car, until you own it completely.
With Musharakah, you’ll make something akin to a down payment that entitles you to partial ownership of the car. You and the bank will agree on the initial ownership ratio, and that will determine how much you have to pay upfront.
Payment flexibility - Unlike the fixed payment schedules mentioned above, with Musharakah you may be able to make larger or smaller payments each month, allowing you to adjust your payments based on your cash flow.
Sale flexibility - In many cases you have the option of selling the car at any time, which means you and the bank will share in the sale proceeds according to the ownership stakes.
Read more: What Are The Pros & Cons of Musharakah Contracts?
When buying a car, you also have to consider insurance. And here too you should consider sharia-compliant options like Takaful.
Takaful is an alternative insurance model where participants pay into a shared pool of funds that is managed according to sharia principles by a Takaful operator that invests the money in sharia-compliant assets.
If you need to access the insurance, you file a claim with the Takaful operator. Unlike traditional insurance, it’s not run for profit and it avoids interest payments and making speculative investments with your money.
Surplus Distribution - Besides ethical investing and greater transparency, Takaful also redistributes surplus funds when more money is collected than is needed to pay out claims. That means you may get some of your money back.
Read more: Comparing Conventional Insurance And Takaful “Islamic Insurance”
Disclamer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
