Murabaha loans elaborated

There have been many special car deals during Ramadan offering Murabaha loans. Can you explain how these work and how it differs to a car loan from a conventional bank loan where interest rates are charged, also what general things should I look out for when taking out a car loan?

Answer: Murabaha is a loan system whereby the bank will purchase the good itself at cost price and sell it onto the customer at a small profit. The contract requires specific instalment payments to the bank which prevents the bank from having to charge interest, which is forbidden under Sharia Law. In terms of buying a car the banks running Murabaha car loans schemes will, at your specific request, purchase the car of your dreams — new or old — from an authorised car dealer and sell it on to you at an agreed profit.

The system means that you know exactly from the start how much the bank is making out of the deal and how much you will be paying-off the loan in instalments every month.

The bank will need to check that you can make these repayments and may ask to see evidence of your salary. However, they usually allow you to take immediate ownership of the car and to spread your repayments over a long period of time

A Murabaha scheme removes the idea of interest rates which are the mainstay of conventional banking. Applying for a conventional car loan will require you to ask for a specific sum of money for a specific vehicle; the bank will check if you can afford the requested sum and that the car is worth the proposed sum. The bank will then determine an interest rate on the loan which will be depend on the total sum borrowed and the period of time you agree for payback. These interest rates can range from between four and 10 per cent and can be calculated in two different ways: a "flat rate" is when the interest paid on each monthly instalment is always levied on the original sum borrowed and so each instalment will be the same throughout the loan period. This is the system used for most personal finance loans across the globe. You need to be aware however that a flat rate interest is not always as low as it appears — a rate of 6.5 per cent for a 48 months period has an effective interest rate of about 12 percent. The other way of working out interest is known as the "reducing principal" where the monthly/annual interest is calculated on the reduced sum and instalments will decrease as the loan period continues. Whichever type of loan you choose there is an important check a list of points you need to go through before signing on the dotted line:

The writer is, Commercial Director, Nexus Insurance Brokers L.L.C. Opinion expressed are the writer's own and do not reflect that of his organisation or of Gulf News.