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A mortgage is one of the most common financing needs for the average person or household, as home prices usually fall far ahead of the average disposable income. It should then come as no surprise that it too has a Shariah-compliant counterpart that is also widely used.
Today, we break down the basic principles and types of a halal mortgage, what distinguishes it from a regular mortgage, and what are the pros and cons of using it.
A halal mortgage or Islamic Mortgage is any type of Shariah-compliant financing used to purchase a home. It is characterized and distinguished from a conventional mortgage primarily by the absence of interest / riba.
If the property in question is commercial, Islamic prohibitions on activities such as illicit goods and gambling also apply.
As with all forms of Islamic financing, halal mortgages replace interest-bearing loans with other forms of funding such as the profit and loss sharing, lease-to-own, cost-plus sales and other asset-backed traction models.
As such, some of the most commonly used Islamic finance contracts are also used to purchase homes. The most frequently used ones include:
In a Murabaha contract, the bank purchases the property and then sells it to the buyer at a mark-up or cost-plus profit.
The buyer will then pay for the asset over an agreed upon period of time, typically in installments. The bank profits from the marked-up sale of the asset instead of interest on a loan.
The markup of the sale to the borrower must be fixed at the time of the agreement and cannot be altered or changed.
As noted in previous entry, Musharaka contracts are partnership agreements whereby the partners – in this case the bank and the home buyer – share in the profits and losses as well as the management of a business or asset (the home).
In a Diminishing Musharaka, the prospective home owner gradually buys out the interest and shares of the bank over time until they own the asset completely.
In an Ijarah-type mortgage, the bank purchases the property and then leases it out to the prospective home owner, with the latter purchasing the property over time.
Typically done through an Ijarah Thumma Al Bai (purchase Ijarah), the transaction involves the signing of two contracts: A standard leasing or renting Ijarah over a fixed period; and a separate purchase agreement that triggers the sale upon completion of the lease.
Know more about: How Ijarah differs from conventional leasing?
Istisna contracts can be used as a method to purchase a home albeit for homes that have yet to be built. In it, the bank and the prospective buyer sign an Istisna contract whereby the former finances the construction of the property – with the contract clearly outlining the specifications of the home and date of delivery.
The buyer can then pay for the home in installments as the bank takes charge of the construction. Ownership is then transferred once the sale and construction are completed.
Read more about: Your Basic Guide to Istisna
Here are the major differences between Islamic mortgage and conventional mortgage, as follow
In a conventional mortgage, the borrower has full ownership and use of the property, which will be used as collateral for the loan obtained from the bank until they pay off the mortgage.
Depending on the type of Islamic financing contract used, a halal mortgage could see the bank own the property until it is bought by the home owner, or the property being jointly owned by the bank and the end buyer.
In a conventional mortgage, the borrower assumes all the risk of the transaction, as any failure to meet their obligations can result in them losing the property and the money already paid to the bank.
Meanwhile, even in the event of a default, the bank will take ownership of the property. In a halal mortgage, the risk is more spread and shared between the institution and home buyer.
In a bull market and low interest rate environment, there is a tendency to use mortgages to engage in property speculation as was the case during the height of the property bubble in the 2000s preceding the global financial crisis.
Islamic prohibitions against overspeculation (gharar) guards against these asset price bubbles and busts.
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
