Conventional Loan Vs. Islamic Loan: Which is for you?
Malaysians have a number of choices when it comes to getting a loan. Personal loans are an excellent tool to manage finances, so it’s no surprise that it is a popular option for many. In general, they can be categorised into four groups - secured loan and unsecured loan, conventional and Islamic loan.
While we’re all familiar with secured and unsecured loans, GoBear will clear the air for you and look at the key features of Conventional and Islamic loans, and help you figure out which one is right for you.
What is an Islamic loan?
An Islamic loan is based on Shariah Laws, the Islamic religious law as stated in the Quran, Hadith and Sunnah. Unlike conventional loans where money is seen as a commodity, there is no money loaned to the borrower as the bank will “purchase” the item for the borrower and sell it to them at a higher price.
The Islamic bank’s financing is structured as a purchase-and-resale of real assets - such as car, house, commodity, or stock - instead of a loan.
It is strictly regulated as it is managed by both Islamic law and finance industry rules. Islamic banks must conform to a variety of principles wherein there is no interest to be charged and products offered are halal and shariah compliant.
Islamic loans which adhere to Islamic Shariah principles strictly rule out all of the following:
- Haram business. This includes alcohol, gambling, etc.
- Riba. Practice of lending at high-interest rates.
- Gharar. Speculative or risky sales where the value is dubious.
- Zulm. Exploitative, oppressive or cruel activities and practices.
Islamic banks in Malaysia operate according to a certain course of action as governed by the Shariah Advisory Council of Bank Negara Malaysia (SAC). The SAC is the most powerful authority on Islamic finance in Malaysia.
What is a Conventional loan?
In conventional loans, the bank lends borrowers money with an interest. Banks then earn a profit from the interest charged on the amount borrowed.
For instance, when you take out a loan, you will repay the loan amount, along with the interest rate and the prescribed rate over a set tenure by instalment. The specified rate is based on a margin above the bank’s base lending rate (BLR).
If a borrower makes a late payment or defaults, the bank has the power to charge additional interests to the amount borrowed. The interest accumulated is a way of paying extra fees when you pay late.
The interest payable may also be capitalised - this means an interest charge is added to the total amount of interest owed since the last payment of the balance.
Tip: If you plan on paying the interest as they accumulate, pay more than the minimum. This way, you can spend less on the interest and eliminate your debt faster.
Benefits of Islamic Loan
Islamic loan has numerous advantages. To point, below are the benefits of an Islamic loan:
- Emphasises the need for financial agreements to be supported by real trade or business-related activities as this provides an efficient boost for economic activity and the economy itself
- Helps lessen the effects of speculation on the economy because it forbids transactions involving Gharar or extreme uncertainty
- Floating profit rates and profit rates are capped at a maximum
- Lower charges are incurred on late settlements
Islamic banks serve for the public interest first, its main objective is to ensure “halal” economic growth. They seek only to do business with Shariah-compliant industries, thus refusing to engage in speculative trading.
Benefits of Conventional loan
Below are the benefits of a Conventional loan.
- Does not need to conform to a ‘halal’ requirement
- Any alterations to the terms of the finance would just need to be up-stamped by the Loan Facility Agreement.
- If you default, restructuring or refinancing is an easier task.
- The costs for early settlements, late payments or defaults are more transparent in the contract.
So which loan suits you as a borrower?
Borrower A: Islamic Loan
Borrower A is looking for a loan with a ceiling rate, which is where an Islamic loan comes in. The transparency of Islamic loans is also appealing as it is based on investment income rather than interest payments, thereby avoiding the complex financial structure used by conventional banks. With an Islamic loan, Borrower A will not be participating and contributing to morally shady enterprises like gambling, prostitution, so on.
Borrower B: Conventional Loan
Borrower B wants to take up a loan, but he owns a string of legal gambling lottery ticket businesses. He can apply for a conventional loan as long as he provides the required income documents. If borrower B plans to increase his loan amount, an additional stamping fee levied will only be needed. Saving the hassle of drawing up a new agreement.
So there you have it! While there are advantages and disadvantages to both types of loans, you can enhance your options by opening both. This way you can maximise your earnings and simultaneously minimise your expenses.
If you’re unsure whether you should get a Conventional or Islamic loan, you can always rely on GoBear’s unbiased comparison tool for personal loans and compare for the best packages and options that suit your needs.