As the element of interest (or known as "riba) earning from lending monies is prohibited from the Islamic context, one of the arrangement for mortgage, "deferred payment sales" (Bai Bithaman Ajil) is utilized to deliver the mortgage service to loan applicants who
The fundamental of BBA concept is indeed very simple. From the initial point of time, the bank would purchase the property from the buyer and resell it at a profit margin to the buyer (or, the loan applicant) while the buyer will repay the new purchasing price on a regular installment basis.
Simple BBA process flow
1. Buyer make the booking of property with developer / vendor
2. Buyer pays the deposit and sign the Sales & Purchase Agreement
3. Buyer applies mortgages from banks
4. Banks evaluate and approve the loan.
5. Proceed with documentation after the acceptance of offer
6. Bank purchase the property from the buyer at Purchase Price (as in the SPA)
7. Bank pays the developer / vendor
8. Bank sell the property to buyer at Selling price (computed based on profit rate)
9. Buyer pays the Selling price by installments
Major concerns of BBA
1. The calculation of Selling price
The standard computation of Selling price is based on the formula as below:
Selling price : Monthly installment X tenure (in months) + grace period profit (if applicable)
in which,
Monthly installment is computed based on the agreed profit rate on a constant rate of return, monthly rest;
Grace period profit is charged during the construction period for under construction properties
2. Profit rates in determining the Selling price
The profit rate which specified in a package can be either (i) fixed rate (will based on the highest of the multi-tiered rates for multi-tier package), or (ii) floating rate (fluctuate in tandem with the movement of a given indicator such as BFR)
The use of (i) in calculating the selling price is indeed straight forward as the monthly installment will be calculated based on the fixed rate, however for (ii), selling price is based on a predefined rate (ie. BFR + 4% or 10% whichever is higher, in which we name it as the "capping profit rate") which is higher than the rate which prescribed in the offer letter (ie. BFR - 1.8%)
Questions always raised for the usage of (ii) in calculating the selling price. The major concern is, as the buyers are paying the installment which calculated based on a capping profit rate which is higher than the profit rate stated in the offer letter, indefinitely, buyers are paying more than what they should pay during the whole tenure (assuming the floating profit rate does not exceed the capping profit rate during the whole tenure). Taking the example above, the rate differential accounts to 5.8% p.a. which is a significant amount throughout the whole tenure. Common inquiry is, what exactly happen to the additional payment / shortfall upon the settlement of loan?
Generally, the differences between the actual profit rate and selling price will be rebated / discounted upon settlement.
Assuming that a loan of RM 100,000 is taken up with variable rate BBA features, BFR - 2% and a monthly installment is calculated based on a fixed 12% profit rate p.a., thus, a simple calculation, RM 12,000 is payable annually. Consider that current BFR = 6.3%, the effective rate for 1st year should be 4.3% instead of 12%. Although clients are stilling paying RM 12,000, the effective payment should be around RM 4,300. The positive balance of RM 7,700 will be accumulated and come in the form of rebate to client when the loan is settled.
Main Advantages
1. As the Selling price is determined within the offer letter during the initial time, clients are certain that the cost of the loan will not go beyond that price in regardless of any changes in the market environment.
2. As the financing is based on Selling price, any additional or "hidden" cost will not be charged to customers without their awareness. Common practice in conventional loan is that any additional charges might go into your outstanding loan amount and compounded but for Islamic loan, charges have to be paid in cash if applicable, thus, the risk of exacerbating the cost of charges is indeed very low.
3. No lock in period. Early settlement can be any time without any penalty. However, it should be noted that some banks might impose the clauses which impose certain amount of fee for early settlement.
Controversy
Controversies raised during the dawn of 2008 as BBA concept was commented by the Middle East scholars that the structure too closely resembles to interest-based financing. One of the issue is the calculation of selling price. The simple formula in calculating the selling price post a major challenges in its identicalness to interest based financing. Consider that,
Selling price : Monthly installment X tenure (in months) + grace period profit (if applicable)
Question is, how do we compute the monthly installment prior the computation of selling price?
To make our example simple, we have a BBA loan of RM 100,000 with variable rate of BFR - 2.1% with capping profit rate at BFR + 4%, tenure 30 years, current BFR at 6.3%.
Apparently, the computation of monthly installment has to base on the traditional amortization formula:
in which the I, Monthly Interest has to be replaced with the capping profit rate, in this case, BFR + 4% (10.3%) in the calculation instead of 4.2% which offered by conventional housing loan (assume that the conventional package can be offered at BLR -2.1%, BLR = 6.3%).
With all of these, effective interest rate at 10.3%, loan amount of RM 100,000, tenure 30 years, the projected installment is around RM 900, thus the selling price should be RM 324,000. In other word, the effective profit margin for the banks is 224% prior any rebate or discount for the clients upon the settlement if no prepayment during the whole tenure.
You should be able to notice a problem now. Throughout the whole calculation and framework is indeed identical to the interest based finance with only one major difference, the rate that used in calculating the installment.
Although the arrangements are different for both (we have a loan agreement for conventional loan but a sales & purchase agreement for Islamic loan), questions and challenges are always encountered on BBA concept in mortgages as clients found that the effective costs of loan are identical among BBA loan and conventional loan with only differences in terminologies and arrangement as the banks would have to maintain at least same level of profitability for both.
Another concern would be the uncertainty over the actual cost of Islamic mortgages. As differences which generated from the gap of the actual rate and monthly installment is calculated and accumulated over time prior the finalization of rebate to the clients upon the settlement, it would be very hard to determine the actual cost of an Islamic loan when time value of money is taken into consideration.
As an effort in promoting the popularity of Islamic financing tools, the government had made their move in waiving the stamp duty for the conversion of conventional loan to Islamic and 20% discount on stamp duty of new Islamic loan to secure the advantageous position of the tools. Thus, lowering the cost of Islamic loan in relative to conventional.
Besides that, in effort of adopting global accepted sharia principles, some of the banks (RHB Islamic, Bank Muamalat) had made their move in diversifying their Islamic mortgage portfolio to musharaka mutanaqisah (MM) concept based Islamic mortgages.
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