Islamic Mortgages are a debt and therefore haram | Why this Analysis is Mistaken 

New models of Islamic home financing have come about over the last few years. Examples include Wayhome, Your Home, Keyzy, Pfida, Crowd2Live and others (collectively, the “Shared Ownership Products”). 

These models are all different to your conventional mortgage and Islamic mortgage in that they typically: 

1. Are not regulated financial products as they are closer to the landlord/tenant relationship than the bank/debtor relationship. 

2. You are usually not required to buy the entirety of the house. 

3. You are usually paying market rate rent on the portion that you do not own. 

4. You will usually be buying the portions that you don’t currently own at either the same price as when you started the transaction, or with a very heavy discount on current market price. 

There are some fundamental structural challenges with all of these products at this moment in time. These structural issues are mostly because of the way UK law operates and because most of these firms are not FCA-authorised. Therefore right now with some products you are not actually allowed to fully buy out the entire house due to tax reasons; others will charge you double stamp duty (as the exemption only applies to regulated firms); and there is usually much less clarity and transparency as to what you’re actually paying relative to the mortgage market (as the firms are not regulated – they are not required to be as transparent). 

On the other hand, there are some very interesting innovative ideas that these products have brought to the table. The idea of being able to take a rental holiday and pay through equity, the idea that the financing company pre-vets your home and even helps you to negotiate it, the idea that you can buy with zero deposit and pay through your rent, and the idea that you can just continue renting a portion of your house with no obligation to buy it out entirely. 

However, our concern today is that some of the discourse in the Islamic finance industry is becoming very polarised and zero sum. Rather than celebrating the innovation of these Shared Ownership Products, we seem to be arguing that Shared Ownership Products are the only halal home finance option out there – and that Islamic mortgages (otherwise known as Home Purchase Plans (“HPPs”)) are not sharia-compliant.  

The problem with that approach is that it is negative and it wolf-whistles at a product that has been signed off by multiple leading Islamic scholars who sincerely believe in their conclusions and have the technical skills to understand what they were opining on – and – most importantly – have sound sharia reasoning to underpin their decisions.  

This approach also collectively reduces trust in the entire Islamic finance community, and when the sea level sinks, so do all the boats on it. And to mix metaphors, once one starts throwing stones at other products and one lives in a glass house, that ultimately ends up hurting us all. 

We have a general point for this article and a specific one.  

Our general point is: innovate with Islamic financial products and celebrate the interesting new solutions – but don’t attack existing products (certified as halal by legitimate scholars) on the basis of sharia-compliance. That is not saying “don’t criticise them” – we can all do that and should (we certainly have). It is saying don’t say they are “haram” or “not sharia-compliant”.  

Our specific point is: traditional Islamic mortgages fare no better or worse from a sharia perspective than a Shared Ownership Product. To evidence that we will outline that: 

1. Those who say “when you are locked in to buy a house this is a debt and therefore no rent can be also charged on top of that as that would be interest” are confused about how Islamic mortgages and home ownership law in the UK works.  

2. Those who say “you cannot rent something you already own” are confused about how Islamic mortgages and home ownership law in the UK works. 

3. Those who say “There are two contracts in one (sale agreement and rent agreement) and this is haram in Islamic law” misunderstand the hadith that details this prohibition as well as the diversity of views across the four main schools of Islamic law. 

“An Islamic mortgage is a debt, and therefore any rent is interest” 

This is a key objection that has arisen over recent years against Islamic mortgages. This is how the argument goes. 

What happens? 

1. An Islamic bank buys 80% of a house and sells you that slowly over 30 years. 

2. An Islamic bank rents its 80% to you and charges you a rent for that. 

Concern: 

1. The Islamic bank has locked you into purchasing the house from them from the very start without any way to suspend, stop, or reverse that purchase. This is effectively a debt (by way of a deferred payment). You now already own the house and are just paying it off in instalments. Therefore, any link to a debt transaction that results in a profit for the bank (the rent) is effectively interest. 

2. The Islamic bank has entered two contracts with you that are directly interrelated and connected with each other. The sale and the rental agreements. 

Let’s deal with the first concern (the second concern we’ll deal with later in the article). 

The Concerned Person is saying “you have already bought the entire house on a deferred basis and, under Islamic law, ownership transfers at offer and acceptance (i.e. upfront) therefore this entire house is yours.” 

The issue the Concerned Person is raising is that if the house is already entirely yours, then you paying rent on it doesn’t make any sense. Also, if the house is already entirely yours, then there is a debt on you to complete the instalment payment and therefore any additional amount you pay on top of the value of the house is interest. 

Let’s assess the facts based on both English law and the Sharia. 

English & Welsh Law 

A HPP product is understood under English law to facilitate the gradual transfer of beneficial ownership from the bank to the ultimate homeowner. The HPP guidance documents state: 

• Under article 63F(3) of the Regulated Activities Order, a regulated home purchase plan is an arrangement under which, at the time it is entered into: 

• A person (home purchase provider) buys a qualifying interest, or an undivided share of a qualifying interest, in land (other than timeshare accommodation) in the UK. 
• An individual or a trustee (home purchaser) is obliged to buy that interest over the course of or at the end of a specified period. 
• The home purchaser (if this is a trustee, this will be an individual who is a beneficiary of the trust) or a related person is entitled to use at least 40% of the land as a dwelling during that period and intends to do so. 
• Where an undivided share of a qualifying interest in land is bought, the interest is held on trust for the home purchase provider and the home purchaser as beneficial tenants in common. 

The crucial points are highlighted in bold. The first point is that there is a gradual buyout of the Islamic bank, and the second point shows that the Islamic bank is the entity that owns the freehold and is holding it on trust for the home purchaser, slowly selling down its equity in the asset.  

So, you do not own the house from the very start. In fact, quite the opposite.  

This is different to a traditional mortgage where the freehold is in the name of the borrower, with the asset acting as a security for the loan taken out by the borrower.  

The point of a regulated (standard) mortgage is that it is a loan (taken out for any reason – be it buying a property or not) secured with land.  

This point is further brought out of in PERG 4.4.10 of the FCA Handbook: “The definition of regulated mortgage contract contains no reference to the purpose for which the loan is being made. So, in addition to loans made to individuals to purchase residential property, the definition is wide enough to cover other loans secured on land, such as loans to consolidate debts, or to enable the borrower to purchase other goods and services.” 

The concept of partial beneficial ownership is a well-established norm in the law – we would rather not waste time evidencing something so obvious –  and the regulatory permissions as well as guidance documentation provided are clear that the HPP is an example of such a partial beneficial ownership and the owner at the start of the transaction is the Islamic bank. 

Therefore, under English & Welsh law it is uncontroversial to say that it allows for one to own part of a land/property asset, and to partially rent out that asset, and that is what the Islamic bank is doing during the course of the financing agreement. 

Given the primacy of the position of urf (custom) in the sharia generally, but in transactional matters specifically, we think the matter simply ends here, and that the sharia would accept a HPP as a legitimate transaction given its prevalence and acceptance by all counterparties and regulators. 

Sharia 

However, let’s also explore the sharia analysis for completeness. 

The Concerned Person would say “it doesn’t really matter what the position is at Land Registry, what matters is the substance and that is what the sharia analysis will attach onto. And in the case of a HPP, the substance is that of someone who is buying a house in its entirety with deferred payments that they are locked into paying over 25 years.” 

However, we would humbly state that this is a mischaracterisation of the construct of the Islamic HPP. Rather than construing it as a single commitment to purchase the equity of the house from day 1, the agreement is more accurately construed as multiple promises (undertakings) from the Islamic bank to the home purchaser that every quarter they will be offered more equity in the house to buy from the Islamic bank. 

Then at the start of each quarter, further equity is offered to the home purchaser and they accept the offer at that point. 

Each quarter, the home purchaser, should he wish, can also counteroffer to buy more equity back above and beyond that the Islamic bank is offering for that quarter.  

At any quarter, the home purchaser can typically also, should they choose, engage with the bank and seek to change to a rent-only mortgage, or extend the term, or shorten it. In other words, there is an agreed course of things, but then there are plenty of ways to divert away from that agreed course of things. Some of these variations are explicit and some variations only surface if you get in touch with the bank and say you’re struggling.  

The reason why this works Islamically is because an undertaking (promise) is not binding under Islamic law but it is binding under English law. So technically, Islamically, the home purchaser is not locked in to buying anything out. 

The reason why this construal is the more appropriate construal is because: 

1. It coheres with the fact that legal ownership is with the bank; 

2. It coheres with the fact that there is a rent being paid every quarter and all papering clearly points to there being a legitimate rental agreement being in place;  

3. It coheres with the fact that beneficial ownership of the home purchaser increases every quarter and their rent reduces accordingly;  

4. There are mechanisms in place to vary terms of the equity purchase every quarter; and  

5. It is the more charitable reading of the contracts. 

The slight downside of this argument is that technically the papering of your classic HPP does not currently set up explicitly as multiple undertakings to sell back equity every quarter. So to some extent there is a “reading in” of this construal. We would recommend that this is made more explicit in the documentation in future iterations of the HPP contract papering that Islamic financing houses do. 

It is also noted that to say otherwise about a HPP as the Concerned Person did – and to construe it as effectively just a conventional loan – is also “reading in” to the HPP agreements. And the construal the Concerned Person does is not nearly so plausible as our construal based on the facts presented. 

There are also interesting precedents in the Hanafi fiqh for a circumstance where one buys a property to sell on to someone else who has said they will buy from you – but wants to build in the protections in case that someone backs out or evolves their thinking. 

Imam Muhammad – one of the three great Hanafi imams –  in Kitab al-Hiyal¹ outlines precisely this scenario and his solution for the buyer (or financier) is to build in an option to return the house within 3 days in case the ultimate buyer doesn’t come through.  

Of course, this is a murabaha (mark-up) structure – while what we are discussing is a musharakah (equity) structure – but it is very instructive that muftis have been tussling with these scenarios for Islamic financiers for centuries – and muftis have been lenient and creative in their solutions to protect the interests of these financiers within the realms of the sharia. 

These are highly technical arguments as one can see – regardless of which side of this nuanced debate you land. You can reasonably disagree with our take. But what pains us is to think that it is on this technical disagreement that certain folks are happy to label things “haram” or “halal” emphatically.  

That should not be so. Particularly when we turn to alternative solutions proposed as the “truly halal” structures – and find that they arguably fall foul of similar technical issues. More on that later. 

“In a traditional Islamic mortgage there are two contracts in one and this is haram” 

The second issue the Concerned Person raises is that there are two interlinked contracts in one. 

Sometimes friction can enter the debate because the Maliki and Hanafi schools take a pretty relaxed approach to this issue, while some other scholars from other schools can take a stricter approach (though even here there is no consensus). 

If we look at the hadith literature on this topic:  

“The first hadith that was reported by Malik (n.d., Vol. 5, p. 657) disapproves combining a loan contract and a sale contract. The second hadith that was reported by Ahmad Ibn Hanbal (n.d., Vol. 2, p. 174) disapproves two sales in one contract (bay’tayn fi bay’ah), and similar to this is the hadith that prohibits two contracts in one deal (safqatayn fi safaqa). Al-Asbahani (1415 AH, p. 267) reported another hadith that states that the Prophet, peace be upon him, has prohibited a sale that is circumscribed with a condition (bay’ wa shart).²” 

Scholars have engaged with the hadith literature over the centuries and the Maliki school, as understood by Hattab has said “all these elaborations had proven that the prevalent view of the Maliki school is the permissibility of the combination of ijara and sale in one deal³”. Among the Shafi’I school scholars like Al-Ghazali and Al-Sharbini have both allowed combing two contracts in one “such as leasing and sale or currency exchange and salam because the contracts involved are valid separately; hence, there would be no objection to combine them in one deal.” 

In the Hanbali school Ibn Qudama also allowed for the combining of certain contracts such as currency exchange and leasing or a sale where taking immediate possession is not necessary.  

The crucial thing the scholars identify as being prohibited is: 

1. Ambiguity in the price, as well as the price itself being uncertain and not fixed. 

2. Uncertainty in any one of the counter-exchanges 

3. Sale with an unlawful condition. 

4. Linking the completion of one contract with the completion of another. 

5. Bay’ al-Inah (selling X to someone and then agreeing to buy it back from them on a deferred payment basis) 

So long as the two contracts are clearly decomposable into separate parts with no interlinking, there is clarity on the price and the items, we would humbly conclude that, based on the above analysis and views of scholars, the sharia sees no issue with such arrangements. 

Accordingly the HPP would not fall under the “two contracts in one” prohibition. 

The important role of Urf 

Let’s say for a moment that we accept that there are some deficiencies in the typical HPP contract terms along the lines of the two objections discussed above (it’s just debt, and it’s two contracts in one). 

Even then, the sharia (particularly the Maliki and Hanafi schools) allows a broad range of flexibility in contracts that are the way they are according to the common practice and custom of the people⁴⁴ as long as they do not go against an explicit and clear-cut text of the Quran and Hadith. 

Given that there have been thousands of HPPs conducted, and millions of mortgages differently conducted, our view is that the current setup of the HPP is accepted by society as a normal contract that differs from the mortgage contract. The HPP contract also has no material element of ambiguity to it nor does it come with any material levels of hardship specific to it as a contract that would undermine its purpose. As such, all these technical arguments are entirely moot and sidestepped by Hanafi and Maliki schools on the basis of urf (custom). 

Coming up with a “truly halal” alternative is not as easy as it sounds 

There are a few attempts that have been made to side-step the regulated HPP product and come up with a sharia-compliant home financing product. 

To our mind there are two primary routes they have gone down: 

1. To adopt the sale and lease concept similar to a HPP but to change the commercials such that both the sale of the asset and the lease are done at broadly market rates. 

2. To adopt the sale and lease concept similar to a HPP and to look to compete with HPP providers and mortgage providers on the commercials as much as possible. 

An example of (1) would be Wayhome and Your Home, Heylo while an example of (2) would be Pfida (and we are sure others we are not aware of). 

The challenge with taking route (1) is that the commercials can become unappealing and one is also saddled with double the stamp duty. 

The challenge with taking route (2) is that one is saddled with double the stamp duty and the product that is created effectively looks very similar to the HPP it purports to be better than. Of course (2) – if it can be made to work is better – as it attempts to compete with the established product. 

If we take a look at how an approach (2) product would play out: 

1. You would typically enter into a long-term lease over the asset. 

2. You would typically strongly incentivise the buyback of the equity in the house every month – but would not lock in the individual to do so. 

The first issue that arises is that when you enter into a long-term lease over the asset and owe rents for it, the sharia regards this as a long term debt that is owed by you to the owner of the house. So you’ve ended up saddled with a long-term debt on one side of the transaction anyway. 

And on the equity buyback side there are also issues. Sure, you aren’t locked into buying back the equity every month, but the commercials are set up such that on every month you do make a buyback of the equity, you get a rent discount, so in total you may be paying £600, with a £400 equity buyback and a £200 discounted rent. But if one month you decide you don’t want to buyback equity that month, your rent discount disappears and you have to pay the full market rent of £650. 

So, sure, you have now created the illusion of “you have complete choice if you buy back from us every month or not” but in reality you have set up the economics so that only a madman would ever take the rent-only option as it would be more expensive.  

And if that’s the answer to a HPP – a technical manoeuvre that somehow makes this approach halal and the HPP haram (and therefore sinful) – we feel that is a deeply unsatisfactory basis from which to make such a claim. 

You add on to that the significant challenge of scaling an unregulated home finance product, and raising money for your financings without having the requisite savings account regulatory licences, and suddenly the HPP route starts looking appealing.

That is not to write off Shared Ownership Products. We think they have a lot of promise, and it is in the intricacy of this manoeuvring and incremental improvement that major breakthroughs and product innovations arise – indeed we are seeing some of these already as mentioned above which is fantastic. We also think Shared Ownership Products should hopefully see acceptance as a new regulated category eventually, and that should herald a new era of growth for the industry which will be fantastic for the Muslim community. Shared Ownership Products need our support – but also friendly constructive feedback and chivvying along in the right direction.

Conclusions 

 As we said right at the start – there was a general point to this article and a specific one: 

Our general point was: innovate with Islamic financial products and celebrate the interesting new solutions – but don’t attack existing products (certified as halal by legitimate scholars) on the basis of sharia-compliance. That is not saying “don’t criticise them” – we can all do that and should. It is saying don’t say they are “haram” or “not sharia-compliant” as that is a bold claim to make without extremely firm footing.  

Our specific point is: traditional Islamic mortgages fare no better or worse from a sharia perspective than a Shared Ownership Product. To evidence that we outlined that: 

1. Those who say “when you are locked in to buy a house this is a debt and therefore no rent can be also charged on top of that as that would be interest” are confused about how Islamic mortgages and home ownership law in the UK works.  

2. Those who say “you cannot rent something you already own” are confused about how Islamic mortgages and home ownership law in the UK works. 

3. Those who say “There are two contracts in one (sale agreement and rent agreement) and this is haram in Islamic law” misunderstand the hadith that details this prohibition and the diversity of scholarly views on this issue. 

4. Alternative products that seeks to sidestep the illusory issues raised in (1), (2), and (3), ending up creating a product that is effectively the same as or worse than a HPP and is certainly not “more halal”.

As ever, we are not muftis and this is not a fatwa. If you are in any doubt about your personal circumstances consult an expert scholar/mufti you are comfortable with and follow that.

Footnotes:

1. رجل أمر رجلا أن يشتري دارا بألف درهم وأخبره أنه إن فعل اشتراها الآمر منه بألف ومائة فخاف المأمور إن اشتراها أن لا يرغب الآمر في شرائها قال: يشتري الدار على أنه بالخيار ثلاثة أيام فيها ويقبضها ثم يأتيه الآمر فيقول له قد أخذتها منك بألف ومائة فيقول المأمور هي لك بذلك، ولا بد له أن يقبضها على أصل محمد – رحمه الله – فأما عند أبي حنيفة وأبي يوسف رحمهما الله لا حاجة إلى هذا الشرط لجواز التصرف في العقار قبل القبض عندهما والمشتري بشرط الخيار يتمكن من التصرف في المشترى بالاتفاق، وإن اختلفوا أنه هل يملكه مع شرط الخيار أم لا؟ فإنما قال الآمر فيقول: أخذتها منك بألف ومائة؛ لأن المأمور له لو بدأ فقال: بعتها منك ربما لا يرغب الآمر في شرائها ويسقط خيار المأمور بذلك فكان الاحتياط في أن يبدأ الآمر حتى إذا قال المأمور: هي لك بذلك، تم البيع بينهما، وإن لم يرغب الآمر في شرائها تمكن المأمور من ردها بشرط الخيار فيندفع الضرر عنه بذلك 
     ↩︎
2. M. Arbouna, p.345, The Combination of Contracts in Shariah: A Possible Mechanism for Product Development in Islamic Banking and Finance.  ↩︎
3. see Al-Hattab, 1398 AH, Vol. 5, p. 397  ↩︎
4. M.H. Kamali, Principles of Islamic Jurisprudence p.375, referring to Irshad by Shawkani, Usul by Badran and Usul by Abu Zahrah, see also كتاب أبحاث هيئة كبار العلماء – الشرط الفاسد في المذهب الحنفي  ↩︎