Mortgages are one of the pressing issues for modern youth, including Muslims. It is a natural human need to have your own accommodation. And today we will discuss such an aspect as a mortgage. Is it permissible according to Islam and are there any alternatives?
There are actually two types of so-called Islamic mortgages: murabaha (sale with a mark-up) and musharaka (partnership). Musharaka – partnersip – is the most popular today.
Musharaka mortgage is a business partnership between you and a bank. Let us say you buy a house for 500 000 rubles and buy a 20% stake in the house for 100 000 rubles. It turns out that the bank owns 80% and will charge you rent for using this 80%. Over time, you gradually buy out more and more of the house stake, so the rent gradually decreases until eventually you own the house outright.
There is one fundamental moment in this issue, which makes this approach Islamic and different from a conventional mortgage. It is that the bank shares the risk of owning the property with you. In other words, the bank holds 80% of the property in its accounts, not a debt of 400 000 rubles. They are fundamentally different things.
Let us have a look at the differences between a conventional mortgage and an Islamic one, as well as find out the reasons why some Muslims prefer a conventional mortgage.
The need to have your own accommodation
This is the most popular argument for a conventional mortgage. People need their own accommodation and in the absence of a viable Islamic solution, a person who cannot otherwise afford a house can take out a mortgage.
However this argument is problematic for the two reasons. Firstly, this is no longer the case that there is no viable Islamic alternative. Secondly, in Islamic doctrine, as a rule, the necessity is associated with an urgent need, when threats to life, security and religion are at stake.
Are Islamic banks a worthy alternative to existing lending?
There are still ongoing debates about the Islamic finance system and the work of partner banks. There are many stereotypes and so-called difficulties associated with this system. Let us take a closer look at the most common ones.
Islamic mortgage is too expensive
This is the most common complaint about Islamic mortgages. However people do not understand that they compare incompatible things. You are comparing a giant with billions of customers and decades of existence behind it to an Islamic bank – a young company in a developing industry, founded only about ten years ago, with a clientele of about 2 million people. This is just not comparable, isn’t it?
Any new company is associated with start-up costs, especially one that is one of the pioneers in a new industry that is still actively testing various products and mechanisms. All these cost money and time. In addition to it, there are certain costs of training professionals and recruiting highly qualified staff.
Banks have to maintain certain liquid reserves in order to remain liquid and to be able to repay depositors when they ask for it. So, for instance, they may need to maintain 10% reserves. However, Islamic banks with their asset-backed mortgages are treated differently from conventional lenders with their debt mortgages. Due to the fact that assets are not liquid, they are not considered to be liquid reserves, whereas debt mortgages are. Thus, Islamic banks have to maintain a higher level of reserves and cannot originate many mortgages, because they are far more constrained in their actions than conventional banks. Consequently, there is no surprise that they charge a higher price for those few mortgages they can originate.
The contracts of a conventional and an Islamic bank are identical
Some people believe that the contracts of Islamic banks are virtually no different from the mortgage contracts of conventional western banks. The only difference is replacing the word ‘interest’ into ‘rate of return’.
However, when you compare the legal structures with each other, you may find a number of differences. In an Islamic mortgage, the buyer enters into a partnership agreement with the bank and a lease agreement, as well as a number of other ancillary agreements. In a conventional mortgage, the main agreement is a secured loan agreement and various ancillary agreements.
The main purpose of the two approaches is to finance one’s purchase of a house and provide the bank with sufficient protection for their loan-investment. Therefore, the use of similar wording is standard practice when writing legal contracts. Given the centuries of perfection of the conventional mortgage contract, one can understand why lawyers of Islamic banks borrow phraseology from them.
However, this is an area in which Islamic banks should strive to develop. This is why it is of great importance that more educated, motivated young people are involved in developing and improving the Islamic finance industry, whether it is from a legal, financial, Shariah or accounting perspective.
Islamic banking is no different from conventional lending
Islamic banks operate under a regulatory framework designed for conventional banks. Part of this regulatory framework stipulates that banks must advertise their products in such a way that is comparable to other products in the market. Since all other banks use LIBOR terminology and conventional interest rates, regulators ask Islamic banks to do the same. But it does not mean that specialists from Islamic banks charge interest. The work of Islamic banks is extremely open and fundamentally denies riba (that is receiving interest, usury). The Islamic finance system does not receive its money from forbidden or dubious sources, nor does it finance activities that are forbidden in Islam.
To be continued…
Ilmira Gafiyatullina
Photo: Creative Commons