Islamic car finance, also known as Halal car finance, is becoming increasingly popular in the UK for Muslims that want to buy a car but don't have the funds to pay for it outright, making finance the only viable option.
Muslims follow Sharia Law - the laws set in the Quran - which states that paying interest is forbidden. The concept is that it makes the rich richer and the poor poorer. There is an inequality in the dealings between the parties that is frowned upon in Islam.
As a result, if a Muslim wants to buy a car, but not outright with cash, the only option permitted by law is taking out Islamic car finance.
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There are pros and cons to such a finance type, and it is not as simple as buying a car with 0% interest.
The interest you would pay on a traditional car finance deal gets calculated and added to the total cost of the car, therefore making the value of the vehicle more expensive, as the interest gets included in its price.
How does Islamic car finance work?
Although it may sound a little complex, the premise is easy to understand and requires less attention to detail than traditional car finance.
When buying a car, rather than the seller adding interest to be repaid over time, they increase the price of the vehicle to include the interest equivalent.
Interest has technically been added in some form because the car is more expensive than if one was to buy it outright with no finance. However, on paper, as there is no interest rate added, it's Sharia-compliant.
Many car manufacturers don't offer Islamic car finance, though some companies specialise in it. If this is an option you'd wish to go down, it's worth researching to find out who can help you before committing to a particular dealer.
It's common to see deposit rates higher on Islamic car finance than traditional due to the total amount you pay for the car being the overall repayment rather than just the vehicle.
Traditional HP car finance example
If you bought a car for £20,000 with a 10% APR on a four-year term, you'd pay £28,000 throughout your agreement. £20,000 for the vehicle and £8,000 for the interest.
Price - £20,000
APR - 10%
Length of term - 48 months
The total cost of the car, including interest - £28,000
Islamic car finance example
Whereas in an Islamic deal, the interest gets included in the overall cost of the car.
Price - £28,000
APR - 0%
Length of term - 48 months
The total cost of the car - £28,000
Islamic PCP finance
Personal Contract Purchase (PCP) requires a deposit, generally 5-10% of the overall cost of the car. Once the term gets underway, you'll make fixed monthly payments until the end of your agreement, when you'll decide to either pay the balloon payment and own the car outright or hand the vehicle back with no extra fees required.
Islamic car finance usually has no option to take out a PCP deal.
Islamic HP finance
Hire Purchase (HP), like PCP, you make a deposit followed by fixed monthly payments until the end of the term. The big difference, though, is once you make all of your repayments, you own the car outright.
Leasing is a good option for those following Sharia Law as no interest gets added to your loan. When you lease a car, you are essentially renting it, so no interest is required. Leasing repayments are generally cheaper than HP or PCP deals. However, you'll have no option to own the car outright; it gets returned to the lender.