"It is surely a good idea to explore how the sprit inherent in the "moral economy" of Islam could enable a just and ethical approach towards the management of systematic risk in economics, in business and finance the way risk-sharing, implicit in Musharaka, works, for example, with lenders sharing the borrower's risk, and the notion of Mudharabah, the sharing of profit. This is very different from the way that conventional finance transfers the risk quickly and frequently onto someone else with profit going just one way." 1
This statement by the Prince of Wales aptly describes what Islamic financing is and its competitive advantage over conventional financing. With the current pace of globalization and technological advancement, Islamic financing is growing rapidly globally. Indeed, like other forms of financing, residential mortgages can also be financed using either conventional or Islamic financing. Undoubtedly, the Islamic model of mortgage financing is not widely known as most banks offer the conventional residential mortgage financing. It is against this background that this article examines what Islamic mortgage financing is, the Islamic rules relating to mortgage contracts, the various types available as well as its comparative advantage over conventional mortgage financing.
Overview of Islamic mortgage financing
Islamic mortgages are becoming very popular globally especially amongst the Muslim faithful's. Indeed, their preference for Islamic mortgages is primarily because of the dual benefit of, being able to own a home through financial means which agree with one's religious beliefs. In addition, traditionally, the preferred financing for acquisition of homes in the banking industry is mortgages. Furthermore, house financing is very close to the spirit of the Islamic financial system as it enhances the promotion of equitable distribution of wealth, and financial stability.
The most popular financing tools used by Islamic Financial Institutions (IFIs) for the provision of mortgage financing is provided under the principles of a special purpose partnership generally known as Diminishing Musharaka. Other Islamic financing tools include Musharaka (partnership in capital), Mudaraba (partnership of capital and skill), Murabaha (cost plus profit sale), Bai Salam (spot payment with deferred delivery), Bai Muajjal (credit sale), Istasna (order to manufacture) and Ijara (leasing).
Islamic mortgage finance differs from conventional mortgage finance in the following ways:
- IFIs are co-owners of the property and share the risk and rewards attached with ownership of the property. Hence, any damage or loss occurred to the property without negligence of client is shared by IFIs according to their equity stake.
- Unlike conventional banks when returns are earned from the date the mortgage facility is granted, under the Diminishing Musharaka, return only becomes due when the property is ready for use either through an acquisition or through construction.
- Whilst conventional banks will continuously receive the repayment installments (comprising of interest & principal) even if the property is not useable and needs some repair, IFIs are not entitled to rents during the period of repair.
- While IFIs will only receive rentals and share any appreciation or depreciation of the property2, conventional banks' returns on the mortgage facility are typically fixed as interest for the tenor of the facility.
Islamic Rules relating to mortgage contract
The Islamic mortgage contract is derived from the elements of general Islamic contracts3 as the Qur'an does not mention the mortgage contract explicitly. The Qur'an, in its verses, contains many rules and principles on contracts in general, and these are applied to create a mortgage contract based on Islamic principles.
Indeed, the Qur'an permits any kind of contract as long as the terms of the contract do not contradict basic Qur'anic rules, especially the one about interest (Riba), which is strictly prohibited. Based on the Qur'anic analogy, an Islamic contract has the same general elements as the English contract, such as offer, acceptance, the complete satisfaction and consent between the parties (the meeting of minds) and the extreme importance of mutual fulfilment, that has been emphasized in many verses of the Qura'an such as Qur'an Sura: Al-Rum, 30:39; An-Nisa'a, 4: 29, 161; Al-Imran. 3:130; Al-Baqarah, 2: 275- 81; Al-Ma'idah, 5:1. So, whilst the Qur'an does not expressly make provision for mortgages, it can be classified as a sale or as part of trade operations which implicitly include buying and selling under Qur,an Sura: An-Nisa'a, 4:29; At-Tawbah, 9:24, An-Nour, 24:37; Al-Jumu'ah, 62:11. 4
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1 https://understandislamicfinance.wordpress.com/2018/02/26/20-quotes-on-islamic-finance/ Accessed 18 August 2020
2 Mohammed Hanif and Syed Tahir Hijaza, infra
3 which are offer, acceptance, capacity, intention to create legal relations and the subject matter must comply with the principles of Sharia
4 https://www.researchgate.net/publication/228121858_The_Applicability_of_the_Islamic_Mortgage_Contract_Under_English_Law/ link/5c02db0b45851523d156986a/download Accessed 10 August 2020
Originally published August 21, 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.