Personal Finance

The problems with Islamic mortgages – and what we should do about it

 

In Part One of this blog I went through why there is very little justification for a conventional mortgage and why so many of the attacks on Islamic mortgages are baseless. Judging from the comments the article instigated, some of you understood that this line of argument was giving my unequivocal support for Islamic mortgages!

In this part I get down to the real crunchy stuff. I go through the major fiqhi issues with currently available Islamic mortgages, and then give some general reflections on what that means for us practically as Muslims living in the 21st Century, and whether we should or should not be taking out Islamic mortgages.

I will be referring to Shaykh Haitham’s excellent article on this topic whenever I feel he has already covered a point adequately – no point reinventing the wheel! Also for the technical buffs in the readership, I’ll be focusing in on the musharakah model. Also for those of you who want a good introductory reading list on the subject, see this previous blog.

UPDATE: Check out our detailed review of Al Rayan here, Can you get a conventional mortgage if you can’t afford an Islamic one? and what is an Islamic mortgage?

Problems with Islamic Mortgages:

  1. They don’t share in ownership risk adequately

Islamic banking is supposed to be a fundamental paradigm shift from lending to an individual where he is exposed to all the risk of the venture and where the bank simply takes its fixed return, to a setup where the bank is seen as much more of a partner in the venture and consequently shares in the risk associated with the house.

Unfortunately four things seem to contradict this.

Firstly Islamic mortgages – at least those that are available in the UK – ask the buyer to take out house insurance on the house so that everyone is covered in the case an alien spaceship decides to land on the house.

Secondly, the Islamic bank also asks the customer to maintain the house and make sure its general upkeep is done. Have a read of this Al Rayan brochure which goes through their whole process. On Page 6 it lays out the 5 different agreements that the customer has to sign up to. The one I’m banging on about right now is the “Service agreement”.

Now if the Islamic bank owned 80% of the house say, then a common sense understanding of house ownership and partnership in a business would suggest that costs are split 80-20 when it comes to home insurance and upkeep. But that currently doesn’t happen with Al Rayan. (It does however happen with some other Islamic banks in other countries)

Thirdly, banks ask the customer to pay the stamp duty upon the purchase of the house. Again this does look like the bank isn’t adequately taking on ownership costs of the house. However I don’t think this is actually a major issue as ultimately the customer does buy back the entire house and should have to pay some stamp duty at some point. Perhaps, rather than getting the customer to pay the stamp duty entirely, the bank should contribute a minority sum towards it, say 20%, as they will after all own a significant part of the house for over 15-20 years sometimes.

Fourthly, Islamic banks do not fully expose themselves to the vagaries of the open market. When you become a partner in a taxi for example, and you both invest £50 each, let’s say your partner gets you to promise you will buy his share off him at £50 in a year’s time, regardless of the then value of the taxi. Given this locked-in price your partner is in effect not risking very much – he certainly isn’t risking loss.

In Islamic mortgage this locked-in pricing happens in the quarterly or six monthly or annual buy-back of a stake in the house. The Islamic bank agrees with you from the start that the house will be sold to you bit by bit at the same price it as bought at by you right at the start of your mortgage. This in effect helps you out, as house prices mostly rise, so if the bank was to work out the market price for its 80% share it would likely be more than what you bought it for.

But of course sometimes it can go in the bank’s favour. Let’s say you want to sell and the house price has actually fallen below what you bought it for. So let’s say you bought for £200,000 and owe the bank £160k. Unfortunately the house is now worth only £150k. In this situation Al Rayan say that they can refuse the sale, but if you really want to sell then you must pay them back entirely. While this is acceptable in the letter of the Islamic law again this doesn’t seem to me to partake properly and fully in the risk-sharing of the venture. In fact all the scholars of all the madahib are unanimous that loss-sharing must be shared, even if profits can be distributed in an unequal manner.

  1. The contract does not use local rent values

The Islamic mortgage uses LIBOR pegged values to work out rent, instead of working out what the local rent would be for the property. This is not ideal however two important things have to be said in defence of this: (a) the Islamic banks usually charge less in rent right now than they would if they charged the local rental value. So in effect the customer is quids in with this practice. (b) It would be quite a task to quarterly or biannually work out new local rent rates for each of the thousands of mortgage properties that the banks will have on its books. So from a practicality perspective this would be difficult.

  1. Fractional reserve banking and money creation

This issue I feel is often one that slips under the carpet as most people discussing Islamic finance often do not have an economics background. Unfortunately the reality today is that 97% of our money supply is created by private interest-dealing banks who simply pop money into existence. You can find out more about how all this works here. Islamic banks too unfortunately operate on this system from the basic research I’ve been able to come across on this subject here and here. What this means is that banks are essentially creating money out of nothing. This goes against the well-established Islamic principle “do not sell that which you do not have”, and raises all sorts of major macroeconomic problems that I won’t go into here. Suffice to say that fractional reserve banking screws up the economy, causes inflation, and puts money supply in the hands of an unelected elite group of bankers.

So if UK Islamic banks also operate according to these practices, and it is highly likely they do, then this is another serious problem with Islamic banking.

So Islamic mortgages have issues with them – now what?

I’ll put down some general thoughts on each of the 3 problems:

Problem 1:  

  • Islamic banks do not exactly take on full ownership risk, but it is not the case that each time they are passing it over to the customer in a way that it is harmful to them. In fact in many cases the bank actually passes the profit to the customer. So in the case of a sale of the property with a profit, the bank foregoes the profit, or in the case of rent, the bank actually takes less rent using LIBOR-pegged amounts than if it worked out the local rent. We usually accuse banks of just milking us dry – but that’s not the case. It is true banks are not taking on a bunch of things that a proper house-owner would, but it’s not true that this is always to the detriment of the customer. This means that the Islamic bank, if it genuinely cannot provide the Islamic mortgage without having to resort to this quasi-home-owner setup, then it can make a much better argument from necessity. “If we didn’t do this, there would be no Islamic mortgage – and it’s not like we’re ripping people off doing this either,” sounds much better than “If we didn’t do this, there would be no Islamic mortgage – and sorry for ripping you guys off.”
  • They do however stack the cards in such a way that makes them mimic conventional finance a tad too much for my liking. Surely the minor things like stamp duty, home insurance, and house up keep could at least be sorted out quite easily? But, as we covered in the last blog this is a young industry that should be supported if it is to progress.
  • Islamic banks genuinely cannot cost-effectively price up houses every quarter and adjust rent every year –or can they? Yes a full house price-up would be difficult as would a rent price up, but perhaps rule of thumb/insight from local estate agent might well be possible acceptable alternative. This would also be a lot cheaper to do than having to send in a surveyor every 6 months or so.
  • Bay’ salam and Bay’ Istisna’ are two kinds of contracts that do lock in prices at a predetermined rate. They were allowable exceptions because the people of Madinah needed it to run their agricultural businesses properly in the Prophetic time. So a similar argument of necessity may be made for the pre-determined house price in an Islamic mortgage.

Problem 2:

  • Similar reasoning would apply here. If the Islamic bank cannot genuinely provide an Islamic mortgage if it were to spend money pricing up local rent values, then they could be justified in what they do.
  • Secondly, as the bank is generally making a loss here even though they are the more powerful party, that plays in their favour for justifying this. This is because foregoing profit is acceptable.

Problem 3:

  • We as a Muslim community are missing the wood for the trees. We’re going after tiny details in an Islamic mortgage not realising that every time we spend any money, bank any money, or make a transaction, we are directly supporting interest-based banking. Every pound that you spend has been created by some interest-based loan somewhere in the background. (check out the Positive Money website for more details).
  • Islamic Banking is pretty much impossible in the current system we have. That doesn’t mean Islamic banks can’t get more Islamic and try and be Islamic as possible in the current system though. But we can’t blame Islamic banks for systemic issues. We can only blame ourselves for that – we vote in the politicians!

So is that a yay or a nay for Islamic mortgages?

Ultimately the decision is yours, and one you should do in consultation with your Islamic scholar, but from where I stand, it seems that in this interconnected and global financial system that we live with today, Muslims need to have a foothold – and Islamic banks are that first foothold. This means that we must support them by actually using them.

However if we’re genuine about our concern to stay away from riba and live in a fairer society, then we need to:

  1. Campaign and lobby Islamic banks to sort out the issues discussed above, and pointed out by a plethora of scholars far more qualified than me. The legally possible fixes should be fixed at least.
  2. Campaign to stop money creation by private banks, move towards a full (or at least fuller) reserve banking system, and empower politicians to do this. Educate the Muslim community on these areas and get more Muslims in the industry to bring positive change. Only once we have such a system in place can Islamic banks really come to the table in the successful way they would like. Right now they’re like a bullet train trying to work on a steam engine track – a track designed for interest-based banks. (And we do need to do this in the UK – we can’t just immigrate to the Middle East or Malaysia – as the financial system there is completely interconnected with ours and operates on identical grounds.)
  3. Come up with our own financial institutions – particularly for halal business loans – that truly are as Islamic as possible given our current financial system. We need to be giving solutions, not just pointing out problems.

Please so comment your thoughts below, subscribe to the blog, and share with friends and family.

PS: I would like to point out that I am not a world-renowned scholar like Mufti Taqi Usmani, Sh. Haitham Haddad etc. What I have presented today are the reasonably informed reflections of someone who has a working knowledge of sharia, economics, Islamic finance, and financial fiqh. These reflections are designed to provoke reflection, debate, and conversation. They’re not a diktat, an edict, or a fatwa.

PPS: Here is another article on Islamic mortgages that I’ve written pertaining the taking out of conventional mortgages by some people.

 

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27 Comments. Leave new

  • Assalam Alaikum bro.
    Thanks for such a detailed blog post. The three problems with Islamic mortgages, you have mentioned are exactly the questions. Also you have not mentioned that under terms of islamic partnership, you cannot charge a “fee” on late payment,

    After reading the article on Islam21c by Sheikh Haitham Al-Haddid, it was quite clear and mortgage offered by Bank Al-Rayan, in it’s current terms are not really halal because the bank in essence is lending you money against a collateral of the house.

    Also, the following lecture by Mufti Taqqi Usmani goes in some length in explaining Islamic finance.

    https://www.youtube.com/watch?v=G0_G2tU0Vzs

    If you are short on time, please watch the points made between minutes 48 and 49, in which Mufti Taqqi has raised concerns about the form of current islamic finance.

    Finally, I would like to comment on your reasoning of using Islamic finance and that we should support it. Suppose, we live in a world where all drinks sold in market contains 5% alcohol. If someone starts selling a drink with 1% alcohol, would you ask Muslims to buy it to support it so eventually there are drinks with no alcohol are sold. I would consider Islamic mortgages in its current form the same.
    Thanks & JazakAllah,
    Hamid

    Reply
    • Can we really compare this though? Banking is a necessity in this day and age, just like a car is for many people which requires car insurance, which has also been deemed impermissible. Alcoholic drinks can be avoided in their entirety due to the availability of drinks with 0% alcohol content and this obviously doesn’t affect us, in fact it works in our favour. Back to the islamic banking, although it may not be perfectly Sharia compliant, this article makes it clear that the way the banking sector is interconnected makes this a monumental achievement, anywhere in the world. Surely it’s better to take steps in the right direction instead of sit back and just say ‘we can’t make it completely Sharia compliant so we will stay idle about the issue’.

      Completely see where you’re coming from though, that just because it is more Sharia compliant but not totally may not make a difference islamically, as it still has impermissible components.

      Allah knows our intentions. And Allah knows best.

      Reply
  • Another stellar article brother. mashallah. Jazakallah for distilling the salient points down. One thing i would like to mention regards business loans. I think thats tricky ground to approach from a practical perspective. Ive been on the start-up and business growth scene for a long time and VC/Angel imvestment is generally a better option for fuelling growth of businesses. Happy to write you an article and submit for your blog if of interest InshaAllah.

    Reply
    • jzk khayr for your kind words and comments.

      We’re always on the lookout for contributing writers – I see IFG as a discussion between lots of people – so it would be great to see an article from you. I genuinely enjoyed your article on Islam21c recently. Very insightful stuff. Email me with some ideas on blog topics iA on ibrahim[at]islamicfinanceguru.com and let’s make this happen 😉

      Reply
    • Jzk khayr for your comment akhi. I definitely rememember replying to this and asking you to email me some ideas at ibrahim[at]islamicfinanceguru.com for ideas on blog posts – I imagine something on entrepreneurship and disrupting the current financial system market would be a fascinating read – but unfortunately that comment somehow disappeared into the ether!

      Anyhow, jzk khayr for pointing that out, and I am very keen alhamdulilah for others to come on board and blog with us iA.

      On your business loans v equity point: point taken. I tend to agree with you, but I do know that there are many smaller Muslim businesses out there who would much rather retain full control over the equity and profits rather than give that away. But again – this might be an interesting discussion to be had for our community: are Muslim businesses being myopic and restricting their growth by doing this?

      Reply
  • Excellent write up MashaAllah. One point though – ‘Islamic banks do not exactly take on full ownership risk’ Agree to some extent on this *but*… they are usually putting up a large sum of money in the transaction so therein lies the risk for the bank. In a conventional contract, the banks holds zero risk as the mortage is securitised and sold on to someone else in the markets. In this case the bank hold 80% of bricks and mortar. So your other concerns about the bank not pulling its weight with regard to ownership are small fry compared to what the bank has done to allow the minorty owner to have in the first place (i.e. a house rather than no house). For that reason I also see it as acceptable for the bank to ask that the stamp duty and up-keep be covered. You could argue that they dont have any risk as they ask for home insurance. Insurance is a potential problem area but there are mutual insurance companies out there that mimick a Takaful contract very closely. There are still many problems as you mention but they are a step in the right direction. Wholeheartedly agree with you that we should support the industry as these are not small efforts being made by Islamic Banks (my inside freinds tell me). If there is no market for them they will disappear and will never return.

    Reply
    • jzk khayr for this feedback and thoughts.

      I’ve been meaning to reply to this for a few days but have been busy, so apologies for the delay.

      I was actually having a discussion with a senior lawyer who was involved in advising the legislatory changes to make Islamic banking possible in the UK, and he said that islamic mortgages are in fact a debt instrument (a secured debt) and there is not in fact a real estate asset on their books.

      This is possible as rather than the house being a business arrangement where both parties have equity, it is better understood as shared ownership similar to the case where you might inherit a house along with your siblings. You can sell your stake in the house at whatever price you like and when you like and if someone else undertakes to buy that share off you then that is a debt obligation.

      Reply
  • Ayman Choudry
    March 26, 2016 11:52 pm

    Salam Brother.
    Just wanted to ask about ‘Qarde Hasan’ that is offered by Ansar Finance?
    Would that be a better option to buy a house? Please advise. Jzk

    Reply
    • Ibrahim Khan
      March 30, 2016 3:28 pm

      ws Ayman,

      Yes Qard Hasan is a better approach of course however Ansar finance no longer offer it for houses. THey do offer smaller Qard Hasan loans however.

      Reply
  • Jazakallah khair brother for this detailed article. I completely agree with you. There are some limitations of Islamic Finance but these are efforts towards right direction we should support Islamic finance. When there will be more customer eventually Islamic Bank will address it.

    Reply
  • I’d like articles about the difference between an Islamic mortgage and non Islamic ones! The reason for that is to see the details of why majority of Muslim community (mainly Asians) go for non Islamic mortgage as it’s cheaper than Islamic one. And in the other hand the minority who goes for the Islamic mortgage are professionals or well established people like self employed with high earnings!
    Also why lot of Muslims use fatwa of necessity to buy non Islamic mortgage, but what’s worse is they use it to buy few more and put them on the market for rent!!

    I raised the points above, because in your conclusion you talked about supporting Islamic banks, and in fact many Muslims choose to go for non Islamic mortgages!

    I believe Muslim community could help each other but they tend to rely and have faith on the system, and only concentrate on building few mosques and take children to Madrassa where possible!

    Jazakallah Allah khair for the article wasalamo alikoum.

    Reply
  • Aslaamu alaikum,

    Very interesting article, and much needed in these times.

    Does anyone know of where we can obtain sharia compliant insurance? I am looking to go ahead with Al Rayan, but do not feel comfortable in getting out the conventional home insurance (they stipulate that you need home insurance).

    Reply
  • Salem Aleykoum
    But Alrayan bank publishes in their site a mortgage sharia compliance certificate:
    https://www.alrayanbank.co.uk/useful-info-tools/islamic-finance/sharia-compliance

    if it is not 100% halal, could you please suggest a better UK? thank you

    Reply
    • @ Bro Karim, please read the article very well plus all those supporting statement from other brothers. Alrayan bank did their best to entice customers and it’s very important for muslim to islam products but the obvious answer to the question of Haram/ Halal clearly shows on the above article and now left to individual to decide.
      Salam Aleykum

      Reply
  • Salaam,

    I was wondering from a shariah view point what would be the arguments against the following structure?

    An investor decides to invest in a house. The homebuyer purchases 30% of the house value from the investor and agrees to pay 70% of current market rental rates. As the homebuyer increases their share the rental costs decrease. The homebuyer may well decide not to purchase the entire house so they are not subjected to any commitment as per conventional mortgage. Furthermore, the risk/reward of the investor is compensated through the rental income and change in market value and the risk/reward of the homebuyer is through the lower rental payments (versus having to rent @ 100%) and change in market value…

    Any thoughts would be much appreciated Jazakallah

    Reply
  • Usman Ajmal
    April 6, 2017 7:35 pm

    Ibrahim, thank you for the well written article. I feel in a banking system so dependent on interest, you’ve listed the most important point (imo) at the bottom of the list: ‘where do Islamic banks get their capital from?’

    I’m happy paying stamp duty, I’m happy taking on risk (I’m buying the house after all), I’m happy paying a fixed profit BUT when Islamic banks start tracking rent with the BOE rate that means the special vehicle used for capital is using an interest based loan. This renders whatever the bank is doing downstream in terms of the product it’s offering as useless.

    Please review and correct me if I’m wrong. I have two indicators that I work on for Islamic Finance (being a rookie and all):
    1- Fixed rate for the entirety of the loan
    2- No eviction risk for late payments,

    Let me know your thoughts.

    Regards

    Reply
    • Ibrahim Khan
      April 17, 2017 3:18 pm

      I don’t think they track LIBOR because they are linking to underlying loans they themselves have. I think they are doing it because it is (a) cheaper than market rent and they actually want to be somewhat competitive; and (b) it makes them comparable to others banks (see the above section on LIBOR.

      LIBOR is itself a good reflection of inflation and economy growth/contraction given its centrality in our financial system, so there are independent reasons for why someone might make reference to LIBOR.

      In terms of your criteria for if x is islamic or not, I disagree with (1) as rent can fluctuate with market prices, and in a musharakah part of your repayment is rent. In a murabaha structure (common in middle east) you will get a fixed rate for the duration of the loan.
      for (2), again I disagree as a landlord does have the right to evict in the case of nonpayment and for the tenant to consequently face consequences for not paying or late payment. An islamic bank should be somewhat understanding, but there is no oblligation on them continuing to be understanding while their tenant continues to fail to meet his payments.

      Reply
  • As-Asalamu Alaykum,

    I’d like to know if there is a true Shariah compliant mortgage institution in Canda.

    Reply
    • Ws,

      In all honesty I couldn’t tell you due to lack of local knowledge. Perhaps some other readers can help when they see this.

      Alternatively, it is worth asking local trustworthy scholars for a pointer towards the right direction.

      Reply
  • The greatest problem with using Al-Rayan and other Islamic bank mortgages come when selling the pretty as my family experiences. They put Al-Rayan as the Registered Owner of the property on Land Registry and put myself and wife as a leaseholder over 25 years. They should have added us joint owners at minimum or put their interest in the property as other banks do.

    This created serious problems when trying to sell the property as they buyer lawyers were pulling out on carrying out their searches. As they believed legally were not the owners and putting the investment of their clients in jeopardy and one went on to say that Al-Rayan back could claim the property back from their client 25 years later
    We were forced to remortgage it with Halifax and even Halifax nominated lawyer pulled out and were luck to find a lawyer that work for Halifax and Al-Rayan Bank.

    Secondly, there is a serious question of what would happen to our investment in the property if Al-Rayan should go into administration etc.

    Reply
  • In the US there is a particular Islamic bank, who uses Murabaha, it claims it will purchase the home we intend to buy then sell it to us for a marked up price, and then have a profit rate depending on how long we decide to take to pay back the money, 10, 15, 20, 40 yrs. I just don’t understand why there needs to be a mark up on the property if the bank will make money from the profit rate, please help me understand.

    Reply
  • Fatuma Abdi
    May 19, 2018 4:46 am

    Asaalam aleykum brother. Jzk. May Allah reward you.

    Reply

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