Walk into Meezan Bank and you will be offered Car Ijarah. Walk into HBL and you will be offered a car loan. The monthly figures often land within a few hundred rupees of each other, which leaves many buyers wondering whether the difference is only in the name. It is not, but the differences are in the structure and the contract rather than in a dramatically cheaper price. This guide explains how each one works and what that means for you in practice.
How a conventional car loan works
With a conventional loan from a bank such as HBL or UBL, the bank lends you the money to buy the car, and you repay that money plus interest, which banks in Pakistan call markup. The car is registered in your name with the bank’s lien on it as security. The rate is either fixed for the whole term or set at 1-Year KIBOR (currently 10.89%) plus a spread and reset once a year. Your monthly payment is a loan installment, part principal and part interest, calculated on the reducing balance.
How Car Ijarah works
Ijarah is an Islamic lease. Under Meezan Bank’s Car Ijarah and similar products, the bank buys the car itself and rents it to you for an agreed period. You pay a security deposit at the start and a monthly rental for using the car. Because the bank owns the asset, it carries the risks of ownership, such as the car being written off, and it is responsible for takaful, although the cost is built into what you pay. At the end of the term, after the last rental, the bank transfers ownership to you, usually by gift or for a nominal price, with the security deposit adjusted against it.
How Diminishing Musharakah works
Some Islamic banks, including BankIslami, structure car finance as Diminishing Musharakah. You and the bank buy the car together as partners. You pay rent for using the bank’s share and, every month, buy a small part of that share. As your ownership grows, the rent falls, and when you have bought all of the bank’s units the car is entirely yours. Economically this looks like a reducing-balance loan, but legally it is a partnership in an asset rather than a debt.
Is Islamic car finance cheaper?
Usually not by much, and sometimes it is slightly more expensive. Islamic banks price their rental using KIBOR as a benchmark, because they compete for the same customers and fund themselves in the same market. The benchmark is used only to set the rental; it does not turn the contract into an interest-bearing loan, according to the banks’ Shariah boards. In our installment plan comparison you can switch between Islamic and conventional banks and see that the spread between the cheapest of each is small. Choose on the basis of the contract you are comfortable with first, and then on price within that group.
The differences that matter in practice
Ownership and registration
With a conventional loan the car is usually registered in your name from day one, with the bank’s lien marked on the registration. Under Ijarah the car is often registered in the bank’s name until the end of the term, which means you will need the bank’s authority letter for some paperwork, and transfer of ownership happens when you finish paying.
Insurance and takaful
Conventional loans require comprehensive insurance, and Islamic products require takaful, a cooperative form of cover approved by Shariah scholars. Premiums are broadly similar. In Ijarah the owner, the bank, arranges it.
Late payments
A conventional bank charges a late payment penalty that becomes part of its income. Islamic banks cannot profit from a delay, so you undertake to pay a late payment amount to charity, which the bank collects and passes on. The cost to you is similar; where the money goes is different.
Total loss of the car
If the car is stolen or written off, under Ijarah the lease ends because the asset no longer exists, and the takaful claim settles the bank’s position. Under a conventional loan you still owe the bank the outstanding balance, which the insurance payout is then used to clear. In both cases comprehensive cover protects you, but the logic differs.
Early settlement
Paying off early is possible with both. With a conventional loan you repay the outstanding principal plus any early settlement charge. With Ijarah or Musharakah you buy the bank’s remaining share of the car at a price agreed at that point. The early settlement calculator gives a good estimate for either.
Which should you choose?
If avoiding riba is important to you, Islamic financing is designed for exactly that, and banks such as Meezan, Dubai Islamic Bank, BankIslami and Faysal Bank all offer it on terms close to their conventional rivals. If you are indifferent, compare the total cost, the fees and the bank’s service, and remember that a fixed rate gives certainty while a KIBOR-linked one can move in either direction each year. The car lease calculator handles Ijarah-style rentals, including security deposit and takaful, so you can see the full monthly amount before you decide.
Leave a Reply