Islamic car finance: interest-free leasing and finance options

Islamic car finance lets you spread the cost of your next car without paying interest and is also known as Halal car finance

BuyaCar team
Jun 30, 2022

Islamic - or Halal - car finance is a way of spreading the cost of a new or used car that's compatible with the faith, allowing drivers to make the most of car finance deals while adhering to Islamic restrictions on money lending with interest and speculation.

This might sound like an excellent way to cut the cost of your car payments, but the truth behind these kinds of deals is that rather than the company charging the cost of lending money in the form of interest, you'll simply have to pay extra upfront, so it's rarely cheaper than conventional finance. In fact, it can often be more expensive overall, while you're often required to pay a larger initial deposit, too.

You also have fewer choices with Islamic finance. The option of PCP finance, which is generally considered to be the most flexible and affordable type of car finance with low monthly payments compared with the value of the car - and the chance to buy the car outright at the end of the contract by making a large optional final payment - is not available.

As a result, it's worth considering what fits your needs better. Yes, some finance setups present the cost of borrowing money in the form of interest, which may not be compatible with Islam. However, you're still effectively being charged a premium for borrowing money by going for Islamic car finance; it's simply that this premium is typically bundled in with the purchase price of the car, rather than being displayed as a separate element, presented as interest. 

Interest-free cars

BuyaCar does not offer Islamic finance, but it is possible to buy a nearly new or used car from the site using Halal finance that has been arranged separately. Or, of course, you can choose to pay for the car with cash and avoid the need to borrow money at all. Meanwhile, it is possible to pay monthly for a new car without paying interest; many new cars are available with 0% APR finance - which is effectively interest-free finance.

Remember, though, that you will almost always be paying more for a brand new car, financed or otherwise, compared to even a one-year-old equivalent. You may not be paying interest with a 0% APR deal, but as new car cash prices are typically so much higher than used alternatives - because cars lose value fastest when new, depreciating more slowly as they get older - even interest-free finance on a new car can involve much higher monthly payments than other finance options on a used car. 

Another alternative that doesn't involve interest is leasing a brand new car. This is effectively a form of long-term car rental and no interest is charged, as you're not borrowing money for the car but paying a monthly amount for access to the vehicle instead. At the end of the contract, which typically lasts two to four years, you simply return the car.

Leasing and PCP finance contracts both set out how much you'll pay in monthly payments over the course of the agreement, and guarantee that customers won't face further charges if the car loses value faster than expected during the agreement.

Penalty fees can be imposed with both leasing and PCP, though, if the car is returned with damage beyond fair wear and tear or mileage above the pre-agreed mileage limit. Late payment charges apply if you miss payments, too, with interest likely to be charged on the outstanding debt. These proceeds are kept by lenders. An Islamic bank would normally pass these payments to charity to avoid receiving interest.

How does Islamic car finance work?

In general, Islamic car finance takes the form of a personal loan. The lender buys the vehicle from a seller and then recoups the money by charging the customer monthly payments over an agreed period of time.

Instead of charging interest, lenders significantly increase the price of the vehicle charged to the customer to cover the cost of lending. As the initial price of the car is higher, the deposit required is also larger, as finance often features a minimum deposit that is typically a proportion of the car's value.

It's not possible to apply for an Islamic finance loan with BuyaCar, but you may be able to arrange this separately and can then use this to pay for a car.

Getting a good deal with Islamic finance

Just like conventional car finance, the cost of your monthly payments under Islamic finance can vary depending on the car you choose and your credit profile - so it's always worth shopping around to make sure that you're getting the best deal.

If you're in a steady job with a good income, then you're likely to be seen as a low-risk borrower, which can increase your chances of being accepted for the best value finance options and may reduce your monthly payments. Putting down a large deposit will also cut your instalments, because you're effectively borrowing less.

Apply for finance

If you are simply looking for the best value car finance, and are open to mainstream finance for a second-hand car and happy with interest being charged - remember that monthly payments are likely to be similar to, or potentially lower than 'interest-free' Islamic car finance options - then you have more finance options available to you.

The best way to compare the cost of car finance deals is to get like-for-like quotes, with the same type of finance (whether that's PCP, Hire Purchase or a loan), contract length, deposit amount and mileage allowance and then see how the monthly payments stack up.

It's possible with many providers to apply for finance online, which can take as little as 15 minutes in some cases. More and more companies make it possible to send proof of ID and to sign and submit documents from home, making it increasingly quick and easy to apply for finance.

Islamic PCP finance

PCP is not available with Islamic finance, so you don't have the flexibility that it offers. However, interest-free PCP finance offers are sometimes available on new cars, and these may be suitable for you.

With PCP finance, the monthly payments are relatively low compared with the value of the car because they don't cover the full cost of the car. However, you also don't own the car once you've made the last monthly payment.

At the end of the contract, there are three options. One is to buy the car for a pre-agreed lump sum - known as the optional final payment - which is typically around a third to half of the car's value at the start of the contract. In many cases - particularly with newer cars - you may be able to refinance this amount to spread the cost of the lump sum, which is effectively the predicted value of the car at the end of the contract term.

The second option is to hand the car back to the finance company and walk away with nothing to pay (provided the car is in good condition and you've stuck to the pre-agreed mileage limit).

Your final option is to effectively trade the car in for another vehicle on a new finance contract. If the car you’re trading in is worth more than the optional final payment to buy it - this is known as having equity - then the additional value in the car can be used to put towards a deposit on your next vehicle, cutting your monthly payments.

Islamic car leasing

If PCP finance is not an option for you and you're looking for a new car, then leasing may be suitable, particularly if you only want to run the car for a couple of years and then hand it back. Monthly payments can be even lower than with a PCP contract, however, you will have to return the car at the end of the contract, with no option to buy it.

You're not charged interest when you lease a car; your monthly payments are simply a rental fee to access the car. However, you also won't be able to own the car at the end of the contract, so you'll have nothing to show for your monthly payments, either.

Islamic Hire Purchase (HP) finance

Hire Purchase (HP) finance enables you to spread the full cost of a car across a deposit and a series of fixed monthly payments. At the end of the contract, you’ll own the vehicle.

Halal HP finance isn't typically available, though interest-free credit Hire Purchase can be offered on new cars. The way that Islamic finance works is similar because you make fixed monthly payments that cover the entire cost of the car and for borrowing the money and you are the owner of the car at the end of the contract.

Monthly payments for conventional Hire Purchase finance are calculated by dividing the cost of the car (£20,000 for example) by the length of the repayment period. Interest is added to the result (apart from in the case of interest-free credit offers), resulting in fixed payments for the entire term. If the total cost of interest were to add up to £2,500, then you would end up paying £22,500 in total.

Islamic finance is based on the value of the car, plus the cost of supplying credit. If the total cost of the car and the credit were the same as the car above, that could add up to £22,500. You'd then repay this amount in equal monthly instalments, though with no formal interest.

Deposits are flexible, but you’ll normally need to put down a certain percentage of the car's initial value for the cheapest arrangements. With conventional Hire Purchase, this is based on the value of the car; a 10% deposit on a £20,000 car would be £2,000. But the deposit with Halal finance is calculated on the full loan amount; so you would need to pay 10% of £22,500 - £2,250.

Assuming the same contract terms, larger deposits lead to lower monthly payments, so the larger deposit should be reflected in lower monthly payments.

*Representative PCP finance - Ford Fiesta:

48 monthly payments of £192
Deposit: £0
Mileage limit: 8,000 per year
Optional final payment to buy car: £2,923
Total amount payable to buy car: £11,926
Total cost of credit: £2,426
Amount borrowed: £9,500
APR: 9.9%

BuyaCar is a credit broker, not a lender. Our rates start from 6.9% APR. The rate you are offered will depend on your individual circumstances.

 

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