The Islamic Mortgage

Haitham Al-Haddad


All praise is due to Allah and may His peace and blessings be upon our Prophet Muhammad, his family and all his Companions.

During recent years there has been an unprecedented expansion in the range of commercial banking products labelled as "Shari`ah compliant" in many countries of the world. Popular interest among Muslims in the Shari`ah of financial transactions has increased likewise, and in the United Kingdom the permissibility of so-called "Islamic mortgages" is among the most frequent topics of enquiry. We therefore thought it appropriate to record here what we see as the main problems associated with this product class from the perspective of Shari`ah, knowing that many of our criticisms can be equally well applied to other types of product that are currently available from the Islamic banking sector. Scholars who have approved the main forms of Islamic mortgage will no doubt disagree with some elements of our criticism. We mean them no harm, and remind the reader that Allah has decreed the existence of differences among people, including Muslims, as one of the tests by which Paradise may be attained.

Although we conduct a purely contractual examination of the issues, it is important not to forget the socio-political context of the discussion. Muslims in the West are attempting to implement certain elements of Shari`ah within an environment that is frequently inhospitable, and the formulation of an appropriate strategy is therefore rather complex. The question is not limited to whether particular financial products are contractually valid. Wider concerns are also in play. For example, is it permissible to establish an Islamic bank that initially has some dealings with interest if the intention is eventually to become interest-free? Should we be content with a structure in which an essentially un-Islamic industry accommodates some Islamic products? Or should banking as an industry be avoided until a completely interest-free opportunity presents itself? If so, how will Muslims satisfy their banking needs in the meantime? Perhaps most fundamental of all, is the Western model of Islamic banking and finance something that can be 'Islamised' in the first place?

When approaching this subject some scholars of Islam may give greater weight to the surrounding context than they do to narrow contractual issues, particularly in Western countries where the institutional and legal framework is rooted in practices that are often prohibited in Islamic law. It is surely unreasonable to expect a wholly Islamic banking paradigm to suddenly sprout from un-Islamic foundations, and some sort of transitional phase is therefore to be expected when developing Islamic alternatives. Moreover, in many countries of the world, Islamic and non-Islamic, the Muslim community is not in a position to effect the wide ranging institutional changes that would be required if a genuine Islamic financing paradigm is to emerge.

Whatever approach is taken to dealing with the problems that face us, we feel that one key rule to be obeyed is that Islamic principles and teachings should not be twisted to fit preconceived solutions. The basic Islamic prescription for success in these matters is, as always, to deal with the causes of a problem and not its symptoms. If we are asked to provide an Islamic solution to the economic problems caused by interest, without eliminating interest, then we say that Islam does not have that solution. To those who argue that "partly Islamic" financial products are an acceptable stepping stone towards an ideal solution, we respond that such products may already be part of the problem.

"Many of today's Islamic financial products are neither presented nor perceived among the Muslim population as temporary solutions dictated by force of circumstance. Because of this, the drive towards improvement in the Islamic finance industry is being diminished. If existing products are already "Islamic", why develop new ones?"

Now referred to as "home purchase plans" by the UK Treasury and Financial Services Authority, Islamic home financing products usually adopt one of three basic forms of Islamic contract. These are murabahah, `ijara wa iqtina (sometimes referred to as ijara muntahia bitamleek) and musharakah mutanaqissa.

Murabahah is a sale of an item to a buyer at a disclosed profit margin over cost. In order to implement a murabahah mortgage, a bank will buy from the vendor the property that is desired by its home-buying client for the agreed price, and immediately sell it to the client at an agreed profit margin over cost. The home-buyer will pay the price of the property in installments over several years, and mortgage the property to the bank in order to secure the installments that are due. Banks that offer this form of finance usually borrow (at interest on the money market) the amount of money that they use to purchase the property in the first leg of the murabahah transaction. The installments paid by the client are therefore set at a level that is sufficient to repay the money borrowed by the bank from the money market, and provide the bank with a profit on the deal. The installments paid by the client must be fixed in total (since a contract in which the price is not specified is invalid under Shari`ah) hence a bank often uses the interest rate swap market in order to fix its interest costs. By fixing its own borrowing costs, the bank can fix its client's installment payments. Rises or falls in interest rates during the term of the murabahah will not then have an effect upon the cash-flows of either the bank or its client.

`Ijara is a rental of an item by its owner to a client, and `ijara wa iqtina is a rental of an item followed by its sale to the client. In the case of home financing using `ijara wa iqtina, the bank will buy from the vendor the property desired by the home-buying client at an agreed price, rent it to the client for a period of years, and then sell it to the client at the end of the period at a price agreed between them at the outset of the contract. The client's monthly payments to the bank will comprise two main payments. One is rent, the other an amount that is held by the bank as an assurance that the client will be able to pay for the purchase of the property when required to do so at the end of the rental period. The "assurance money" is loaned out at interest by the bank to the money market, producing a financial benefit for the bank. The client's monthly payment under an `ijara corresponds approximately to the payments under an amortizing interest-based loan in which capital and interest are repaid in changing proportions over the term of the loan. This similarity allows a bank to easily adapt its interest-based lending processes to the requirements of an `ijara mortgage.

Musharakah mutanaqissa is a diminishing partnership between a financier and a homebuyer. There are several ways in which this partnership can operate. In the case of the Al- Buraq scheme in the United Kingdom, the bank purchases the property desired by the home-buying client using its own funds plus a deposit provided by the client. Although the property is registered in the name of Al-Buraq at the Land Registry, the diminishing partnership contract splits the so called "beneficial interest" in the property between the bank and the client so as to reflect the relative size of their contributions to the purchase price. The client now lives in the property as a tenant and pays rent to the bank. The amount of the rent is adjusted to reflect the fact that the client owns part of the beneficial interest in the property. In addition to the rental payment, over time the client buys the bank's beneficial interest in the property and eventually becomes the owner of all of that interest. At this stage, the client's total rental payment is zero and the final formal step is taken of transferring ownership into the name of the client at the Land Registry. It should be noted that in some other diminishing partnership contracts, the property is held by the financier in trust for itself and the client. Of itself, this modification need not affect the cash-flows described above.

Ahli United Bank in London offers products that are described as murabahah and `ijara. United National Bank, HSBC, and Al-Buraq offer what they call a diminishing partnership contract. The Al-Buraq contract has been adopted by Bristol and West, Lloyds TSB and Islamic Bank of Britain. Until recently, HSBC offered an Islamic home financing contract in accordance with `ijara wa iqtina principles, but this has now been replaced by its diminishing partnership product.

The Islamic principles of financial transactions are found within a part of Islamic law called muamalat. As a rule, muamalat states what is prohibited, not what is permitted. If a contract can be shown to contain a prohibited feature, it is deemed void or partly invalid under Islamic law. The onus is on the one who prohibits to prove his case, not on the one who permits. Hence, it is not for the bank to show that its mortgage product is halal (permissible). Rather, it is for detractors to show that the product contains a prohibited feature such as riba (usury, of which the charging of interest is one form) or gharar (deception or uncertainty in contractual terms). It is worth pointing out that the fashion of issuing religious judgements to approve financial products as halal goes against this basic legal approach. However, it seems that the spread of riba and unlawful features within most contemporary financial transactions has encouraged Shari`ah scholars to issue such judgments to signify conformity rather than non-conformity.

Islam defines riba in such a way as to prohibit any benefit received by a lender for the giving of a loan, no matter how big or small the benefit. (Riba can also occur in certain other forms of trading transaction that we do not deal with here.) The main point for our purpose is that modern interest falls under the scope of the riba prohibition. In contrast, a transaction in which goods are exchanged for money cannot contain riba. This is called trading. It is however possible that such an exchange will be invalid on other grounds, such as coercion or misrepresentation. Muslim merchants are therefore allowed to make a profit by selling goods for more than they purchased them, but they are not allowed to make a profit by lending money. This is the way in which we may understand the Qur'anic injunction that:
{... Allah has permitted trading and forbidden Riba (usury)... } [Surah al-Baqarah
from ayat 275].