Sunday, June 8, 2014

Case Study: Is Islamic Home Financing in USA Halal?

In the Name of Allah, the Entirely Merciful, the Especially Merciful.

All praise is due to Allah, Al-'Alim (The All-Knowing)

 "And whatever you lay out as usury, so that it may increase in the property of men, it shall not increase with Allah; and whatever you give in charity, desiring Allah's pleasure-- it is these (persons) that shall get manifold." (Quran 30:39)

Several years ago, I was sitting outside the masjid and waiting for iftar, and one of the brother engaged with me in a conversation about Islamic finance in USA, and how it is just another name for interest (riba). According to my knowledge at that time, structure of the loan was similar, but terms made it halal. So, I suggested him to take the islamic loan, if it is the same, and have faith in the scholars who have passed the fatwa. From that day, my secondary interest, beside fiqh in general, has been to learn about Islamic Finance in modern age. How can we buy a home without having the full amount in cash?

Some say that one shouldn't buy a home, if they don't have cash, because they shouldn't desire things that they can not afford. Others say that if we don't understand the difference, there is no difference between conventional loan and Islamic loan. Both are extreme views and does not need any further attention here. We should be able to pursue our dreams in this world using halal methods, but at the same time, we should strive to go towards less doubtfull, and Allah knows best. Specially, when a believer says that Islamic loans looks the same, so they can not be halal, without understanding the fatwah of the scholars, they are playing with fire. Even if the scholar is wrong, one is obliged to followed them, unless one has a indisputable proof from Quran and Sunnah.

"...they say, "Trade is [just] like interest." But Allah has permitted trade and has forbidden interest..." (Quran 2:275)

So, purpose of this article is to share the knowledge I have gathered in last 3 years with everyone, and not to ask anyone to sell their homes immediately, due to their loans are not completely halal. As always, we will start with the golden principle of Islam, which makes everything in this world and in our imagination permissible, unless it violates any rules of Sharia. So, all business transactions and loan terms are permissible, unless there is a defect which invalidates that transaction. In USA, there are two major types of home financing Ijara (Lease to Purchase), and Musharaka Mutanaqasa (Declining Partnership). I will be showing how these are halal theoretically, and how practical implementations in USA could put doubts in them, and how they can be improved.

Main reason for establishing these Islamic Financing Institution is to provide a halal alternative in USA to interest based loans. Of course, Alternative to interest is trade, and we need to see if these profit based Islamic financing transaction qualify as trades, or do they fall short of the basic requirements. So, what are the basic requirements for a profit based Islamic financial transaction to be trade and not Riba(Interest). Saif ul Azhar explains the requirements as the concept of 'Iwad (Equal Countervalue) in the following way, and many of the early and modern scholars like Imam Ghazali agree with these criteria. 'Iwad means to take risk, have liability, and make effort to earn the halal profit from the trade.

"I need to make this point clear to prevent undue confusion. For example, when the polytheists in the city of Mecca say, "Trade is like riba..." and the Quran detested it by saying "Allah allows trade (al-bay') but prohibits riba," the former, i.e., al-bay' implies the existence of 'iwad, or equal countervalue in the transaction. When the requirement of 'iwad is fulfilled in trading (al-bay'), it brings along the sense of equity and justice into business transaction, that rendered it superior to an interest-bearing system"  (page 30 Saiful Azhar - IBF)

First, in Ijara (Lease to Purchase) financing, the home is owned by a trust. Then, the customer sign a lease agreement with the trust, where they pay the rent and separate on-account payment towards buying the home. Trust holds the title and maintain the property taxes. At the end of 30 years the Trust transfers the title to customer. This is completely halal, as the customer doesn't own the title directly, and buys the home slowly.  Following are the issues with the implementation of this in USA ( based on my own home financing).

1) Financier should bring halal funds and not have conventional loan at the back to finance their share of the funds. Also, customer can not be asked to sign a mortgage with any of the investors of the financier ( usually conventional bank will require that). This is completely unacceptable in Islam, and defeats the purpose.

2) Customer should not be a full trustee on the trust, but the lease agreement should be structured to protect their right as usually the case with leasing to purchase contracts. This is a very common transaction in USA. Giving customer part ownership is unacceptable.

3) If the home is sold before the customer purchase the property, the profit of the sale should be divided according to the share of funds paid so far by the customer. This is to keep the intention of the transaction as honest. It is unjust to give full profits to a lessee for a property owned by someone else. Imaging your tenant asking for that.

Second, in Musharaka Mutanaqasah (Declining Partnership) financing, the home is bought as a partnership between a sub-corporation of financier and the customer according to their share of the funds. After the purchase, the customer is allowed to live in the property as a privilege, and in return they pay rent. They also pay a small amount to buy back the share from the financier. After 30 years, the customer owns 100% of the partnership, and hence owns the home completely. This is completely halal, as the home is purchased as partnership and there is no loan. It is also allowed to purchase the share of other partners, and pay the partner compensation of exclusive use rights. Following are the issues with this type of implementation (based on case study of a home in Windermere, FL area, proof documents are available upon request).

1) Although the property is purchased as partnership, the financier does not appear on the title. According to the fatwa, this is done to provide the customer the conveniences they usually have with conventional loans. Ownership only exist on a contract that is never recorded in the county, which means legally it is not a true ownership in partnership. Scholars seems to allow it, because Islam recognized signed contract as a legal bind. However, that allowance is only in the cases, where local laws allow it, and we are required to follow the laws of the land where we live in. In this case, scholars need to require both partners to be on the title. According to the requirement of 'Iwad (Equal countervalue), we have to take the risk, liability, and effort of partnership, to reap the benefits of this being an Islamic transaction. This is completely unacceptable.

2) Although the financier owns majority of the property, they do not take any responsibility of the property. If roof leaks, or taxes are not paid on time, they are not liable. This is exactly the unjust relationship conventional banks have with their investment. They provide cash, and collect rent on the cash. Since they are not collecting rent on the property, they usually don't get involved in the day to day operation. Islamic financier are not renting money, but renting the property, so they need to take responsibility. This is completely unacceptable. Financier should manage the property, or pay someone to do that. Just waiting idly to collect rent is dangerous, as per the following hadith.

From Usamah ibn Zayd : The Prophet, , said: "There is no riba except in Nasiyah [waiting]." (Bukhari, Kitab al-Buyu', Bab Bay' al-dinari bi al-dinar nasa'an; also Muslim and Musnad Ahmad)

3) Customer is allowed to take tax break available for Mortgage Interest for the rent they pay. That is completely unacceptable. If the intention of the rent is to pay the partner for the use of the property, it need to be disclosed as such to the government. Deception to allow a convenience to the customer that they have with conventional loans is not allowed in Islam. This is completely unacceptable. There is a reason IRS provides this break only for interest, and not for rent payments. We can't have it both ways. Customer should not use this, even if they are provided, because of the following verse.

"O those who believe fear Allah and give up what still remains of the Riba if you are believers. But if you do not, then listen to the declaration of war from Allah and His Messenger. And if you repent, yours is your principal. ..., then everybody shall be paid, in full, what he has earned. And they shall not be wronged." (Quran 2:278-281)

4) If the home is sold before the customer owns 100% of the property, the profit of the sale should be divided according to the share of partnership. This is to keep the intention of the transaction as honest. It is unjust to give 100% profits to one of the partners. Financier play a trick to make this happen. They will allow the customer to buy their partnership first, and then let them sell as 100% owner to gain the profit, but since the customer has no money to do that, they execute the contracts simultaneously to avoid this paradox. This is completely unacceptable. Financier should benefit from the profit or take the loss according to their ownership, because they claimed that they owned it to make this transaction halal. If they back out from that claim, then only Allah knows what comes of the whole transaction.

"... Deal not unjustly (by asking more than your capital sums), and you shall not be dealt with unjustly (by receiving less than your capital sums)." (Quran 2:279)

"And be afraid of the Day when you shall be brought back to Allâh. Then every person shall be paid what he earned, and they shall not be dealt with unjustly." (Quran 2:281)

Yes, these restrictions will reduce the benefit to the customer compare with conventional loan, and make the financing less competitive against conventional loans, but there is a reason Allah called Riba unjust (profit), and if the benefits to parties are similar in both transaction structures, then there is no justice. If it does not attract most Muslims, so be it, because those Muslims may not be ready to understand the benefit they will receive in hereafter, by giving up rights, which are unjustly entitled to them in an interest based loans. In essence, Lease-to-Purchase, and Declining Partnership financing is completely halal, if implemented according to the intention of that type of transaction, and not a restructured debt loan on deferred payments with profit, which is the definition of interest based loans.

According to my little knowledge, these implementations of the halal alternatives are not 100% compliant with Sharia requirements yet. Scholars have singed on to this as halal, according to their understanding. So for people, who are not able to determine these defects, they should continue choosing halal options over conventional. For people who already have a conventional loan, or these pseudo Islamic loans, they should not oppress their families by selling their property immediately, but find a transition plan. For people who can buy on cash, go right ahead, but please do not discourage people from halal financing, as it may lead to extreme hardship, and destruction of their faith in Islam. Reducing great harm with minor harm is one of the principle of Islam.

Next step for me is to reach out to the scholars, and seek out their opinions on these apparent defects. Find out, if they understood the details in USA, when they signed the fatwa, and if they conitnously montior these facilities. For this purpose, I will be travelling to Chicago, inshAllah, for the Islamic Economic Conference. I will share what I learn when I comeback, God Willing.

If any of you have more information that removes these defects or explain how they are not, please feel free to forward it. As I mention, I also have one of these type of financing on my home, and that is my primary purpose of this research. I would continue the research, and see what else I can find out.

I would like to end this with the hadith that Muhammad ibn Ismail Al-Bukhari started his collection with. Basically, it comes down to the intention of the person and the transaction, and if the intention is pure, business will come and homes will be bought. Bending the rules to the extent that they reaches boundaries of prohibited areas is not a wise business plan. Let us keep striving for halal.

Umar ibn al-Khattab relates that he heard the Messenger of Allah, say, "Verily actions are by intentions, and for every person is what he intended...." (Agreed upon)

JazakAllahu Khairin

A struggling homeowner
AbuArman Jumani

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