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Opening New Doors

June 2016

Islamic refinancing offer product sophistication and depth of options at par with conventional refinancing options

While assuming debt is discouraged in Islam, it is not prohibited per se. It is understood that certain situations may warrant taking on financing; however, the same needs to be assumed responsibly ensuring one’s capacity in servicing the same. Differing from a conventional setup, Islamic financing works on the basic principle of equality, necessitating risk sharing amongst the parties involved. As an example, in the case of a Musharakah Mutanaqisah contract of home financing, each rental payment (which could be related to the Equated Monthly Installment in conventional finance) increases the debtor’s equity stake in the property until the last payment where the title of equity is transferred to the buyer in full. Evidenced is a much more level playing ground for both parties, a stark contrast from the otherwise interest centric lender-borrower relationship. The contractual nature of the financing facility thus mandates a thorough comprehensive and proactive platform taking into account methods allowing all aspects of debt management.

As interest rates globally have trended lower, it is imperative to take a relook at the financing one may have availed off. This is even more critical in cases where the obligation is of a significant amount – an example in case is home financing. If you can save even 1 percentage point from your current financing rate, refinancing would makes sense. To present a perspective, and it is useful to use the example of conventional financing in this case, a loan of AED 500,000 for a 15 year tenure at 6.5% interest rate translates to an interest payment of ~ AED 283,997; same loan at an interest rate of 5.5%, leads to a saving of AED 48,622 or nearly 20% of the interest obligation.

Refinance allows owners to reduce the cost of their mortgages, thus allowing a higher degree of financial flexibility in the longer term. It may be used to trigger a host of benefits, including lower monthly repayments by either moving to a lower profit rate or extending the tenure of the financing, faster settlement of debt, consolidation of debts or a move from a floating profit rate to a fixed rate or vice versa. One of the aspects of critical importance in refinancing within the Islamic Finance framework is Shariah’s mandate outlining that there cannot be an increase in the overdue amount.

A more recent concept is that of debt consolidation, which is an extension of the concept of refinancing. Consolidating your loans involves grouping all pending payments into one combined debt. So whether it is an outstanding car financing availed, an overdraft or a house mortgage, one is able to merge all these debts into a single debt. Dubai Islamic Bank lists the same offering as Liability Settlement Finance allowing an individual to combine all payment obligations into one easy finance solution at a Sharia-based profit rate.

Whatever be the case, taking on debt necessitates prudence on the part of the borrower. While refinancing may seem attractive, it is essential that one conduct the due diligence around processing fees, rescheduling fees, early settlement fees amongst others. The market presents a host of opportunities, with leading banks competing in offerings around refinancing and consolidation – equipped with knowledge around the same, it would ensure repayment of the debt would be a smoother journey.

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