How do halal mortgages work and are they acceptable to take out?

Your question is in regards to Halaal mortgages. At the outset, i’d like to point out that these Shari’at compliant loans systems have been verified by leading contemporary scholars such as Mufti Taqi Uthmaani.

There are two ways in which this loan system works:

1) Muraabaha- Murabaha is the most popular and most common mode of Islamic inancing. It is also known as Mark up or Cost plus financing. The word Murabaha is derived from the Arabic word Ribh that means profit. Originally, Murabaha was a contract of sale in which a commodity is sold on profit. The seller is obliged to tell the buyer his cost price and the profit he is making. This contract has been modified a little for application in the financial section. In its modern form, Murabaha has become the single most popular technique of financing amongst the Islamic banks all over the world. It has been estimated that 80 to 90 percent of financial operations of some Islamic banks belong to this category. The Murabaha mode of finance operates in the following way: The client approaches an Islamic bank to get finance in order to purchase a specific commodity. An interest-based bank would lend the money on interest to this customer. The customer would go and buy the required commodity from the market. This option is not available to the Islamic bank, as it does not operate on the basis of interest. It can not lend the money on interest. It can not lend money with zero interest rate, as it has to make some money to stay in the business.

Some portion of total finance may be offered as an interest free loan, however, the banking institutions have to make profit in order to stay in business. Hence, what course of action is open to the bank? The Murabaha model offers a solution. The bank purchases the commodity on cash and sells it to the customer on a profit. Since the client has no money, he buys the commodity on deferred payment basis. Thus, the client got the commodity for which he wanted the finance and the Islamic bank made some profit on the amount it had spent in acquiring the commodity.

There are a number of requirements f or this transaction to be a real transaction to meet the Islamic standards of a legal sale. The whole of Murabaha transaction is to be completed in two stages. In the first stage, the client requests the bank to undertake a Murabaha transaction and promises to buy the commodity specified by him, if the bank acquires the same commodity. Of course, the promise is not a legal binding. The client may go back on his promise and the bank risks the loss of the amount it has spent. In the second stage, the client purchases the good acquired by the bank on a deferred payments basis and agrees to a payment schedule. Another important requirement of Murabaha sale is that two sale contracts, one through which the bank acquires the commodity and the other through which it sells it to the client should be separate and real transactions.

The Murabaha form of financing is being widely used by the Islamic banks to satisfy various kinds of financing requirements. It is used to provide finance in various and diverse sectors e. g. in consumer finance for purchase of consumer durable such as cars and household appliances, in real estate to provide housing finance, in the production sector to finance the purchase of machinery, equipment and raw material etc. However, probably the most common and the most popular application of Murabaha is in financing the short-term trade for which it is eminently suitable. Murabaha contracts are also used to issue letters of credit and to provide financing to import trade.

2) Ijaarah- Ijarah can be defined as a contract by which “one person transfers usufruct (use) of a particular property to another person in exchange for a rent from the tenant” (Adapted from M Taqi Usmani’s “Ijarah”, p.1). In other words, the term Ijarah is comparable to a conventional leasing mode of financing. You pay rent for the use of the property, instead of paying interest on the loan amount. The bank purchases the property either from the Seller, or you in the case of refinance, and then lease it to you over an agreed term.

The distinguishing feature of this mode is that the assets remain the property of the bank. Over the term of the finance, the bank become the landlord and you assume the role of tenant. During this period you make monthly payments which consist of a contribution towards the purchase price of the property (capital) and rental payments. When you have made enough ‘capital’ contributions to match the original purchase price, the bank transfers the property to you.

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Mufti Yaseen Shaikh