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Islamic car finance explained

  • Islamic car finance lets people buy cars with 0% APR
  • How leasing negates interest rates
  • HP and PCP generally not interest-free

Islamic car finance, or Halal car finance, is aimed at people following Sharia Law, a set of moral laws according to the Quran, the religious text of Islam.

Islamic car finance allows you to spread out the cost of a car, while following Islamic law that forbids interest rates.

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How does Islamic car finance work?

Conventional finance agreements, usually, charge an interest rate - a percentage charged on the total amount you borrow or save, which is typically paid for monthly.

There are several strands of Islamic finance, but Islamic car finance generally works on the basics of a personal loan, and is actually quite simple.

The buyer buys the vehicle from the seller. Instead of the seller making money by charging interest, the seller increases their price to cover the money they would have made by adding an interest rate. Because there is no interest rate added, it's Sharia compliant.

For instance, if you bought a car from a dealer for £10,000 on a Hire Purchase style agreement with a 5% APR rate, you would pay in total £10,500 over the course of the agreement (assuming for ease that the agreement is over 12 months). £10,000 for the car, and £500 in interest.

With an Islamic agreement, the dealer would pre-load that £500 worth of interest on to the price of the car. So you would pay £10,500 (spread over a set of fixed payments) for the car, not £10,000.

Deposit rates on Islamic car finance are generally much higher than traditional forms of car lending because the are based on the overall repayment you make, rather than just the car.

Most car manufacturers don't offer Islamic car finance specifically, but there are a number of companies who specialise in it. Banks such as Lloyds TSB also provide Islamic bank accounts.

Car finance deals:

Islamic car finance: leasing

Leasing (also known as PCH) is an elegant solution that negates interest costs. You're not charged interest when you lease a car, you simply rent it. Therefore it is Islamic compliant.

Leasing payments are usually lower than HP or PCP payments too. Of course, you can't buy the car at the end of the agreement, so you'll never own it.

Islamic car finance: Hire Purchase

Hire Purchase spreads the car's cost across a deposit and a number of monthly payments. Once you've paid all of the monthly instalments, you own the car with nothing left to pay.

Hire Purchase agreements aren't technically available with Islamic finance because while the cost is spread, interest is added to your monthly payments.

Islamic car finance: PCP

PCP (Personal Contract Purchase) contracts usually require a deposit (although don't always require it) followed by monthly payments. Should the customer choose, they can buy the car for a pre-agreed sum at the end of the contract term or simply hand it back

PCP finance agreements are also unavailable with Islamic car finance, once again, because interest rates are added.

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