How Does Islamic Car Finance Differ From Conventional One

Posted Date: Sat Jul 2016

In the recent times past, Islamic Finance has gained a lot of ground within Pakistan. As an Islamic country, the majority of our population is muslim and thus this factor has allowed financial solutions based on Islamic principles to gain a strong foothold because people think it as a modus operandi of following what our religions teaches us and acting upon Allah’s commandments. Auto Finance is one of the many other Islamic financial solutions being made available to the public by various banks in Pakistan. How Islamic auto finance works differently in contrast to conventional auto finance is majorly based upon the factor of interest. Whilst conventional financial solutions have practices that include interest, whereas Islamic finance practices do not indulge into any practices that include interest. The presiding principle in Islamic finance is that all forms of interest are forbidden. Hence Islamic finance model works on profit sharing in which the bank and the customer agree to share the risk of any investment. However Islamic auto finance basically works on Ijarah principle of Islamic financial methods that do not include profit sharing as that’s only done in Mushraka or Modaraba. Ijarah is such a financial transaction in which an asset is given to the person by the financial authority I.e bank and is an installment based leasing agreement in which the owner ship of the asset remains with the bank until the installments are fully paid. Hence it’s a type of a hire purchase where the user reaps the benefits of the asset and ownership is transferred  to the user when he has fully paid the outstanding amount of the asset. Some of the terms and conditions that apply to ijarah agreements are as follows: 1) The leased asset such as car should be transferred to the lessee upon the maturity of the agreement and the asset should be in such a condition that it’s fit for usage and working in the required tasks. 2) The amount and duration of the installments should be agreed upon in advance by both the lessor and lessee. However the timing and amounts don’t need to be uniform. 3) The duration of lease must be specified. 4) The terms and conditions of the usage of the leased asset must be stated. 5) The lessor should have legal ownership and possession of the asset before leasing it. 6) The leased asset should continue to exist during the period of lease. Any items that can be consumed during usage cannot be leased. 7) If the installment is delayed due to any reason then the ijarah agreement may be terminated right away. 8) The lessor can claim for any damages to the leased asset caused by the negligence of the lessee. So in a nutshell, you have to pay a decided amount as down payment and the rest has to be paid in installments. In Ijarah, the bank and the person purchase a car together. Now suppose the Bank has paid 85% of the total value of the car. Thus you’ll have to make two types of payments to the bank: a) Since you own only 15% of the car at the time of the agreement, you have to pay the installments  to acquire the 85% of the bank’s share in the car which will enable you to become the owner of the asset. b) You have to pay rent for using 85% of the bank’s investment in your car. This will decrease with time as you’ll be acquiring a bigger share in the car with time and the rent depends upon the bank’s existing share in the asset. To make it even more clear, let’s take an example. You are buying a new Suzuki WagonR VXR which costs a total of PKR 959,000 for a tenure of 5 years and your security deposit aka down payment  is set at 15% which comes out to be PKR 143,850. There’s a small processing fee as well. If you’ve selected 5 year plan then you’ll be paying PKR 20,850 as installments over the course of 60 months. After you’ve completed the installments, you may transfer the car to your own name. We hope this article clarifies how the concept of Ijarah works. If you have any comments/feedback please let us know at