Mediterranean Knights goalkeeper Muhammad Nashnoush's performance and a poorly-aimed attempt that went wide from Ghana's Joshua Tijane clinched the victory following a lacklustre game.
A fast-paced start raised expectations of an energetic clash, but play slowed after the first 15 minutes and failed to recover.
The match ended goalless after extra time, mirroring the result from both semi-finals.
The best goal opportunities appeared in extra time, when play picked up as both teams frantically tried to score in the quarter-full 64,000-seater Cape Town stadium.
Having come on the pitch late in the second half, Libya's star scorer Abdelsalam Omar failed to add to his two earlier goals in the tournament.
He came close to breaking the deadlock 16 minutes into extra time, but his header in front of the box went straight into 'keeper Stephen Adam's hands.
Adams made several daring saves during the game, but was left dumbfounded when it was most important in the penalty shootout.
Here Nashnoush dealt a psychological blow to the West African side by blocking their first two attempts.
Libya become the third champions of the tournament, which is reserved for home-based players from around the continent, joining Democratic Republic of Congo who won the inaugural edition in 2009 and Tunisia who won in 2011.
Earlier in the evening Nigeria beat Zimbabwe 1-0 for third place.