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Taken at face value, Ijarah is simply a form of shariah-compliant leasing or renting. But as we discussed in a previous entry, when used in combination of various separate purchase agreements and other contracts it can be used as an effective form of financing to purchase an otherwise unaffordable asset.
This not only brings it on par with more conventional forms of leasing agreements, but also confers on them (in some cases) unique advantages to both the lessee / buyer and the financing institution / lessor.
However, ijarah contracts do come with their limitations and disadvantages. Today, we will look at the advantages and disadvantages in ijarah compared to other, more conventional forms of leasing when it comes to using it as a financing tool.
Ijarah contracts in its various forms provide an interest-free form of leasing and financing to purchasing (and at times even the construction) of assets such as real estate and equipment. Lease payments under ijarah contracts are fixed, providing predictability without being impacted by interest rates.
This makes it much more affordable and convenient than more conventional forms of leasing or regular loans that institute lease interest payments.
Using ijarah contracts to fund the purchase of an asset requires no collateral making them more convenient than other forms of loan agreements.
Read more about: How SMEs Can Obtain Collateral-free Financing?
This element works both in favor the lessee and the financier. In a standard ijarah, the lessee bears no risks in the event of structural damage that is not attributed to them.
Their sole obligation being to pay for any maintenance or damage incurred from their use of the asset even if the asset is leased with an intention to be purchased.
While the financier retains the ownership risks (including guaranteeing the quality, taxes, customs, insurance, etc.), they also retain full ownership for the duration of the lease.
This is opposed to conventional leasing or mortgage financing, whereby the property is technically owned by the lessee, and hence the asset cannot be sold or its value recouped in the event the lessee is unable to make their payments.
Read more about: How ijarah differs from conventional leasing?
The lessee gains immediate use of the property without having to own it outright or make a large down payment on the asset. This is especially true as ijarah on its own does not oblige the lessee from purchasing the asset.
Ijarah contracts clearly specify the terms of use, lease payment schedule and responsibilities without any hidden fees, early termination clauses or penalties (which are forbidden in ijarah contracts).
Because there is no interest, the lease payments are fixed, and the lessor bears all the ownership risks, leasing payments are usually higher than those of their more conventional counterparts.
This is compounded by the fact that they require security deposits, which are typically more costly than conventional leases.
Unlike conventional leasing contracts, an ijarah cannot be terminated unilaterally without mutual consent. This makes them even more binding for the lessee if circumstances require them to forgo the property.
In a conventional lease or mortgage, if the lessee views the asset as uneconomical, they can transfer the lease or sell the asset and have a smooth exit.
The lack of flexibility in terminating the contract may see the lessee more likely to lose out on their security deposit if they are unable to make their lease payments.
Because all ownership rights are retained by the lessor during an ijarah, the lessee is at risk of losing their right to use the property in the event the owner is sued or declares bankruptcy regardless of whether the lessee has paid up to 90% of the lease, Islamic finance professor Mahmoud A El Gamal rights in his book on Islamic Finance.
He does note, however, that there are workarounds to this, including setting up special purpose vehicles that hold ownership of the asset regardless of
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
