What is Islamic mortgage and how does it work?

Key Takeaways:

• Islamic mortgages are interest-free home purchase plans that are Shariah-compliant and approved by AAOIFI.
• The Islamic mortgages follow the Islamic financing models of Ijarah, Musharkah, Mudarabaha, or Wakalah.
• Islamic mortgage providers benefit by selling the house at a higher price to the homebuyers to profit from the sale because taking interest is forbidden in Islam.

Islamic mortgages or home purchase plans are interest-free mortgages that are Sharia-compliant and approved by Accounting and Auditing Organization for Islamic Financial Institutions AAOIFI.

Islamic Mortgage vs Conventional Mortgage

Although the Islamic mortgage is very similar to buying a house through a regular mortgage, there are a few key differences. Generally, instead of paying interest payments to the bank to pay off the loan, you’ll pay rent payments to the Islamic mortgage provider.

Conventional mortgage providers offer a loan to the customers at interest to buy a house. Because the mortgage is a large loan, the payment occurs over several years and the mortgage providers profit through the interest charged.

In the Sharia-compliant mortgage model that follows Ijarah and Musharkah, you and your Islamic mortgage provider will jointly purchase the house. Your down payment will become your share of the house and the rest will be paid by the lender.

You will have to pay a monthly rent to the Islamic mortgage provider and with each rental payment, your ownership of the house would increase. Upon the completion of the agreed payment term, when all payments are made, the ownership of the house will be transferred to you.

In an Islamic mortgage following the Murabaha model, the bank will purchase the house for you and resell it to you at a higher price to earn profit. The monthly payments you’d pay to the Islamic bank or lender will include a pre-agreed profit.

Fatwas on Mortgage

Conventional mortgages are not permissible in Islam because they involve riba or interest which is one of the major sins in Islam.

Most Islamic scholars including Bilal Philips, Yasir Qadhi, and Mufti Menk are of the view that conventional mortgages are haram, and Muslims should only buy their houses through an approved Islamic mortgage company.

However, Shabbir Ally, the President of the Islamic Information & Dawah Centre International in Toronto gave a slightly different opinion on the problem. He said that although it is preferable to mortgage your house from an Islamic mortgage provider when there are no Islamic mortgages available, Muslims can take a conventional mortgage as the last resort.

This is because taking riba or interest is forbidden in Islam. Because the Muslims are paying interest to the mortgage company, they are not the takers of interest. But again, interest-based mortgages should be avoided if there are interest-free alternatives available.

Types of Islamic Mortgages

There are four major types of Islamic mortgages based on the Islamic model of profitability they follow.

Ijarah

Although Ijarah can also mean ‘rent only’, the Ijarah home purchase plan requires the home purchasers to make monthly rent + capital payments to purchase the house.

To buy the property, the home purchasers put down a deposit. The lender purchases the house for the client and begins charging monthly payments for an agreed period. The lender becomes the owner of the house and lets the purchasers live in the house in exchange for a monthly payment that includes part rent and part capital.

Diminishing Musharaka

In a diminishing Musharka, the buyer and the Islamic lender jointly purchase the house. For instance, the homebuyer deposited 20% to buy the house. This 20% will become his share and the lender will have an 80% share at the time of buying the house.

The buyer can pay the lender through regular monthly payments to increase their ownership of the house. As the ownership grows, the shares are transferred to the buyer. Upon completion of the payments, the entire house will be transferred to the buyer.

Murabaha

Murabaha means ‘profit’ and it refers to the idea that the buyer and seller can agree on the profit margin that the seller would charge the buyer on the sale item.

In a Murabaha model, the Islamic lender buys the property for the buyer and sells it to them at a higher price to profit from it. The profit margin is decided mutually by the lender and the buyer.

Interest is not allowed in Islam but the sale for profit is allowed which means that the Islamic bank or lending institution can buy at a low price and sell at a higher price. With a payment plan in place, the lender accepts to sell the house at small monthly payments during the decided term of 10, 15 or 30 years.

Murabaha contracts also work for business property, equipment, and car loans.

Wakalah

Wakalah is a type of Islamic loan where the lender becomes your ‘Wakil’ or lawyer and negotiates the price of the house and comes up with the payment arrangement for you. The Wakil benefits financially by charging a fee or pre-agreed profit margin on the purchase.

Islamic Mortgage Providers in U.S and Canada

There are several Islamic mortgage providers in the U.S and Canada that you can consider if planning to purchase a house through a Shariah-compliant mortgage. All the Islamic mortgage providers on our list follow the guidelines set up by the globally recognized Accounting, Auditing and Governance Standards issued by AAOIFI.

American Finance House LARIBA

The LARIBA Bank is one of the oldest and most prominent Islamic banks providing financial products and services to the Muslim community in the U.S. It operates in all 50 states and allows Muslims to buy their own house through Islamic financing.

The LARIBA allows the client to become its agent or wakeel to purchase the property. The property is purchased jointly by the client and the bank. LARIBA lets the client then buy the shares of the usufruct. The client and the LARIBA set up a payment plan and decide the total amount that will be paid by the client to completely acquire the ownership of the house.

To purchase a house through LARIBA, you can pre-qualify for the home-buying loan and apply online through their website.

UIF

The UIF Islamic Financing offers mortgages to Muslims in the U.S. UIF also won the #1 Islamic Real Estate Financier (Global Award) in 2020 and 2021. They are known for their quick financing and for closing in most customers within 30 days.

The UIF offers an arrangement where the UIF and the homebuyer enter a partnership agreement for the purchase of the house. The homebuyer’s down payment and the UIF’s capital contribution go towards the purchase of the house. Then the UIF receives the payments from the client in the form of monthly rent for using their share of the property. The arrangement is for a fixed period such as 10, 15, 20, or 30 years after which the buyer becomes the owner of the house.

Devon Bank

Devon Bank has been offering Islamic mortgage loans and home refinancing from traditional loans since 2003. It currently offers Islamic home financing in approximately 34 U.S states.

The bank purchases the house for the client. The client and bank enter a Murabaha contract and set up a payment plan that allows the client to make regular payments at their pace. At Devon Bank, customer service is exceptional, and the clients receive expert guidance regarding their unique situation when buying a house.

You can get prequalified for the halal home loan online or visit the Devon Bank branch for a personalized experience.

EQRAZ

EQRAZ offers unique Islamic finance solutions to homebuyers in Canada. The Ijarah and Diminishing Musharkah models do not work best in Canada because both owners would have to pay capital gains taxes and land transfer tax leading to double taxation.

Therefore, EQRAZ offers Murabaha-based Islamic mortgages that comply with the Shariah and Canadian laws. To prequalify for Shariah-compliant mortgage financing or refinance an existing mortgage, you can submit an online application within 10 minutes.

Manzil

Manzil is both Shariah-compliant and an associate member of the AAOIFI. It is an Ontario-based Islamic mortgage provider that offers both Murabaha and Musharaka home financing models. Both models have their own benefits and drawbacks therefore, the clients can decide on one that suits them.

Manzil compares both halal home financing models of Murabaha and Musharaka, side by side on their website. You can also find details of the procedure each follows for halal mortgage financing. You can create your account at Manzil within just a few minutes to apply for a halal mortgage.

Conclusion

Your house is both an investment and a haven for your family. Buying your own house is a big step towards financial security. It is worthwhile to consider Islamic mortgages because they offer competitive prices and ensure that your home purchase is Shariah-compliant. Getting an Islamic mortgage will also give you the peace of mind that your financial transaction is halal.