How do Islamic mortgages work? We explain here the 3 most popular ways of Islamic mortgages. It helps you to understand how you can obtain your dream house and property under Islamic banking products.
Home Islamic Mortgage is a prevalent terminology describing the way to own and purchase your dream house or property. “What exactly is an Islamic mortgage?” or “What Is an Islamic Mortgage and How Does It Work” — this is a common question. The short answer is that what some refer to as an Islamic mortgage is not a mortgage loan at all. In some ways, Islamic home financing is similar to a mortgage, but its foundation is completely different. Islamic home financing is interest-free, and it is a halal (or permissible) way for faith-conscious Muslims and non-Muslims to purchase a home.
Islamic Home Financing vs. a Conventional Mortgage
Lending money to profit from any commercial or investment activity, including the financing of real estate, is not an acceptable method of commerce, according to Islamic law. To put it another way, riba (or interest) is forbidden. The most obvious reason is that a loan is considered a form of charity in Islam (qard al hasan) – an opportunity for one person to assist another who is in a difficult situation. The lender should only expect to receive for the amount lent. A loan is not a means of making money.
It is not also acceptable in Islam to purchase or sell something that has no intrinsic value. A loan with interest is essentially a way of repaying a loan with more money. Islamic Finance developed a home financing program on an entirely different foundation in response to a mortgage loan arrangement that was clearly unacceptable according to Islamic financial guidelines.
Islamic home financing is a moral and equitable way to meet financial needs. It is not for the believers of any particular faith; rather, it appeals to anyone who is into a more transparent and ethical financial system. And Islamic home financing is an excellent option for both Muslim and non-Muslim families looking to purchase a home that reflects their values.
Three Types of Islamic Mortgages
The most common Islamic home financing models and structures that are broadly offered by many Islamic Banks worldwide are either based on Murabaha, musharakah, and ijara.
Murabaha
What is Murabaha? Basically, it is the way of selling and buying. Instead of banks lending their money and charging interest to you, the bank acts as an active trader, goes to the seller, and upon request of you as a customer. The bank purchases the house and then sells it back to you at a mark-up price. Murabaha here is that the Bank disclosed the profit margin in the sales between you and the bank.
The most common structure of Murabaha is called bay ‘ bi thaman ajil (BBA) or differed payment sale. In this structure, the bank purchases the asset from the supplier on a cash basis and sells it to the consumer on credit. The credit price comprises the asset price plus the bank’s profit. At the time of contract execution, both parties must agree on the determined price.
Musharakah
It is a partnership agreement in which partners share the profits and losses of a business. Musharakah is a type of Shirkah al-Amwal (or partnership), which in Arabic means “sharing.” Since Shariah prohibits interest in lending, it allows the distribution of profit to be among the partners on pre-agreed ratios, while each partner shares the losses in proportion to their contribution.
Musharakah Mutanaqisah or diminishing partnership is the common structure in Islamic home financing. This structure combines the contract of musharakah, ijarah, and bay’. First, it consists of Musharakah between bank and customer in buying the house with the shared capital of usually 90% and 10% respectively. Second, the bank rents the house to the customer through an ijara contract. Finally, the customer will buy the house gradually representing the bank’s share until the house is fully owned by the customer. In the end, the customer purchases the house from the bank through a sale contract (bay’).
Ijara
How does ijarah work? Imagine you are the customer. You approach the Bank with the request for financing and enter into a promise to lease agreement. The Bank purchases the item required for leasing and receives the title of ownership from the vendor. The Bank makes payment to the vendor and leases the asset to you as a customer. The customer makes periodic rental payments as per contract. At the end of the tenure, the customer can purchase the asset from the bank with the help of a separate sale agreement. Islamic Finance recognizes this structure as al ijarah thumma al bay’ (AITAB).
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