Islamic Mortgage Loans – How Do They Work?
As has been mentioned in previous articles on this website, Islam prohibits ribaa, the paying and receiving of interest. Because of this, Islamic banks and Islamic finance institutions have come up with Islamic home lending products that follow shariah rules. Up until the late 1990’s these products were offered only by a few Islamic banks in the Muslim world, such as HSBC Malaysian and the Islamic Bank of Kuwait.
In recent years, however, Western lending institutions have begun to realize the untapped potential of the Muslim market.
European banks have led the way, such as Lloyds TSB, the fifth-biggest bank in Britain, and Islamic Bank of Britain (IBB).
A few brave USA banks following suit, Devon bank in particular. In fact Devon now estimates that as much as 40% of their home loan business now consists of Islamic finance products.
Non-Muslims have also begun to utilize some of these Islamic finance products. Hindus and Sikhs in Britain have signed up in large numbers because of a perception that Islamic finance products are more ethical than the interest-based systems.
Murabaha Islamic Home Loans
A common type of Islamic home loan is the Murabaha transaction. Actually I’m calling it a loan for the sake of convenience, but in reality it is not a loan or even a mortgage, but a straight business transaction.
In a typical Murabaha Islamic mortgage transaction the bank does not loan money to the buyer to purchase the home or other property. Rather, the bank buys the home itself (at a price that is disclosed to the end buyer), then re-sells it to the buyer at a profit. The buyer typically pays a fairly large downpayment (anywhere from 10% to 30%) or provides strict collateral. The buyer takes up residence of the home right away and the property is registered in the buyer’s name. The buyer makes payments to the bank (without interest).
The Murabaha type of purchase scheme can be applied to goods of all kinds, not only homes or real estate.
Islamic Home Purchases – Ijara or “Decreasing Rent” Scheme
The Ijara or “decreasing rent” Islamic home purchase scheme is common among Islamic banking institutions in the West. In this scheme, the bank once again purchases the home and re-sells it to the buyer. However, unlike the murabaha plan, in the case of Ijara the home remains in the bank’s name until the total price is paid off. The buyer takes up residence immediately and makes payments to the bank on the purchase price. However, in addition to those payments, the buyer also pays a fair market rent. So initially, the buyer is shelling out a lot of money every month.
As time passes and the buyer continues to pay off the purchase price, his share of the home increases and his rent consequently decreases. Eventually the customer buys out the bank and assumes full ownership of the home.
Problems With The Islamic Home Purchase Schemes
These schemes are not perfect.
In Britain, because the home is purchased and sold twice, the stamp duty must be paid twice. This cost is transferred to the home buyer.
In the USA, because there is no traditional mortgage loan and no interest, the buyer misses out on the tax breaks given by the government for the payment of mortgage interest.
These problems will have to be worked out before Islamic home finance can really become viable for the common Muslim. But for the moderately wealthy, or for those simply desperate enough to take on the added costs, at least there are Islamic finance alternatives that did not exist only a few years ago.