Islamic Mortgages and Shariah Compliance: Murabahah, Ijarah (Rental), and Musharakah Mortgages – and Late Fees on Instalments

Islamic Mortgages and Banks

By Abu Khadeejah ʿAbdul-Wāhid

All praise is for Allah, the Lord of the worlds. May the peace and blessings of Allah be upon the noble Prophet, his family, his companions and all who truly follow him.

Halāl mortgages, also known as Shareeʿah-compliant mortgages, are financial products designed for Muslims who wish to purchase a home while adhering to Islamic Law (i.e., the Shareeʿah). In Islamic finance, the concept of ribā (usury or interest) is strictly prohibited, as it is considered sinful, exploitative and unjust. Therefore, halāl loans offer alternative structures that are supposed to comply with Islamic law. There are two common types of mortgage and loans used by banks and finance houses all over the world that offer a halāl alternative to interest-based loans: Murāhabah and Ijārah.

Halāl mortgages are structured to be compliant with Shareeʿah Law, ensuring that Muslims can own homes without compromising their religious beliefs. However, it’s important for individuals considering a halāl mortgage to consult with scholars or experts in Islamic finance to ensure the specific product aligns with their understanding and interpretation of the Shareeʿah Law.

Murābahah Mortgage

One common type of halāl mortgage is the Murābahah mortgage. The term is derived from rib-h which means profit. This arrangement involves the bank purchasing the property on behalf of the customer and then selling it to them at an agreed-upon higher price. The customer pays back the bank in instalments, making it similar to a conventional mortgage. However, instead of charging interest, the bank earns profit by adding a markup to the original purchase price, which is disclosed to the customer.

In this scenario, a person comes to a bank seeking money to purchase a house or another commodity (car, land, farm, etc.). A ribā-based bank would offer the money to the applicant and require that interest be paid when they return the borrowed money. In the Murābahah system, a person finds the house he likes and is determined to have. Then he goes to the bank and secures a Murābahah transaction [from them] whereby he requests from them to buy the property he has found, and he promises to buy it from them thereafter at a price they fix between themselves. Then the bank agrees to purchase it. So this is stage one. And in this, there is a problem if the bank compels the client to purchase something from them that do not yet own.

Stage two is when the person buys this house from the bank at a higher cost than when he originally found it because the bank sells it to him through a deferred payment schedule, e.g., monthly instalments.

The two contracts are distinct because combining them is not allowed in the Shareeʿah, because two contracts in one are prohibited. Furthermore, the bank is not allowed to force an agreement from the client to sell him a commodity they do not yet own because that opposes the Shareeʿah Law.

Some of the people in our times have permitted this type of Murābahah mortgage. However, the scholars of Sunnah have laid down conditions for this type of Murābahah to be a permissible transaction:

1. The bank (or institution) must purchase the property outright and completely before they can sell it to the buyer. The Prophet (salallāhu ʿalaihi wasallam) said: “Do not sell what you do not own.” (Abu Dawood 3503, saheeh)
2. The property must be in the custody of the bank (or institution). So if it is a car, it must be in their car park or warehouse, and it must be in their name (through legal documentation), the house keys and deeds must be in their name and possession so they can be handed over. The Prophet (salallāhu ʿalaihi wasallam) said: “Whoever buys some food, let him not resell it until it has taken it and stored it.” (Bukhari 2126) Ibn ʿAbbās (Allah be pleased with him) said: “I consider that all purchases are like this example.” (Muslim 1525) Ibn ʿUthaimeen said: “And similarly with garments, animals, cars, and so on. Its possession is established by taking it away [from the place of purchase] because this is the custom (in trade).” (Ash-Sharh al-Mumtiʿ 8/381)
3. There should be no intent to use deception to enter into interest (ribā)—for example: it is harām for a bank in a Murābahah transaction: that a client brings to them a property where the bank is asked to buy it from a business whom the client himself has a share in (or complete ownership) because in this situation the client sells a property for money, then purchases it back from the bank with a delay in paying bank. Scenario: Mr Zayd has a house (in the name of his company called ‘ZA Ltd’). So, Mr Zayd tells the bank that he wants a house owned by ZA Ltd. So, ZA Ltd sells it to the bank for £100,000. So, Mr Zayd gets £100,000 cash from the bank (because he needs the cash!) Then the bank sells the house to Mr Zayd for £150,000 which he takes 10 years to pay back (in instalments). What Zayd has done [in essence] is taken a loan from the bank over 10 years at £50,000 interest.
4. It is not allowed to charge a late fee if the instalment is paid late because that is clear ribā—even if the late fee is taken and given to the poor and needy as some loan companies stipulate. (See the Al-Majmaʿ al-Fiqh al-Islāmi concerning al-Baiʿ bit-Taqseeṭ, 6th gathering, Jeddah KSA, 17-23 Shaʿbān 1410AH / 14-20 March 1990 CE)
5. It is not allowed for the bank to bind the client into an agreement to buy a property from them that he has found for himself because they do not own it therefore they cannot make him agree to buy it once they have bought it. The Prophet (salallāhu ʿalaihi wasallam) said: “Do not sell what you do not own.” If the client chooses not to buy, then that is his choice.

The scholars have stated that it is not permitted to sell what a person does not own, and then purchase the product and give it to the buyer. It is also not permitted to buy a product and then sell it while it is still at the place of the original seller before he has taken legal possession of it. Both of these acts are forbidden. Hakīm Ibn Hizām asked: “O Messenger of Allah, a man came to me and wants me to sell him something which is not in my possession (i.e., I do not own it). Should I buy it for him from the market?” He (salallāhu ʿalaihi wasallam) replied, “Do not sell what you do not possess.” (Abu Dāwūd 3503) And he (salallāhu ʿalaihi wasallam) said, “It is not allowed to combine a sale and a loan in one, nor is it allowed to sell what you do not own.” (Abu Dāwūd, 3504).

He (salallāhu ʿalaihi wasallam) also said, “Whoever buys food, let him not sell it until he has received all of it into his possession.”

The Prophet (salallāhu ʿalaihi wasallam) said, “Do not do what the Jews did by seeking through trickery to make lawful things that Allah prohibited.” (See, Irwā al-Ghalīl of Al-Albāni, 5/375, no. 1535)

A person says to another, “Go to a car dealership, choose a car and I will buy it. Then I will sell it to you on instalment payments.” Or he says, “Go look for a house on sale that you like, and I will buy it. Then I will sell it to you on instalment payments.” Ibn ʿUthaimeen stated that these are methods of trickery employed to indulge in ribā (usury). The businessman who purchases these items does not do so as an act of charity (or goodness) to ease another’s hardship. He only buys to gain the increase in wealth through instalments from the one in need.

Ibn ʿAbbās (may Allah be pleased with him) was asked about a man who sold another man a piece of silk cloth for 100 dirhams to be paid at a later date. Then he buys it back from him for 50 dirhams. So Ibn ʿAbbās said, “This is selling silver coins for silver coins for an increase (i.e., ribā) but they used a piece of silk between them [in order to justify the transaction].”

Ibn al-Qayyim said, “This is ribā, the forbiddance of it follows in meaning and reality. The forbiddance does not change by changing its name.” (Tahdhīb as-Sunan 5/103 of Ibn al-Qayyim) The seller is not released from the burden of trickery by claiming, “I am not forcing him to take the goods I bought for him.” That is because he knows that the buyer is in need and will not change his mind.

That is because the businessman (or bank) has ensured that the buyer will not pull out of the pre-arranged deal. This is what many Muslims indulge in in our times (in Europe and the US) through banks that encourage people saying, “Go look for a house on sale that you like, and we will buy it. Then we will sell it to you on instalment payments with an increase in profit for ourselves.” So a person finds a house costing $100,000. He informs the bank that he has found a house. The bank buys the house and sells it to him for monthly instalments that amount to $200,000 after 20 years [as an example].

Ibn ʿUthaimeen (rahimahullāh) stated that these are methods of trickery employed to indulge in ribā (usury). The correct and ethical method for a businessman, company or bank is to buy cars or houses, etc., and own them outright. Then sell them to whoever wants to buy them upon terms of instalment payments, even if that entails a price increase. This method is free of trickery and exploitation and free of ribā.

Ijārah (Rental) Mortgage

Another type of mortgage that is considered halāl (at least by some) is the Ijārah mortgage. In this arrangement, the bank purchases the property and then leases it to the customer for an agreed-upon period. The customer pays rent to the bank, which may include an element of ownership that gradually transfers to the customer over time. At the end of the lease period, the ownership of the property is transferred to the customer, usually through a gift or nominal payment. In a nutshell: “one person transfers use of a particular property to another person in exchange for a rent from the tenant” (see M Taqi Usmani’s Ijarah, p.1) In other words, the person pays rent to the bank for the use of the property instead of paying interest on the loan. So, the bank purchases the property and agrees to sell it to the client for instalments (like a mortgage but without the interest) but it also leases (rents) it to the client over an agreed term. In this scenario, the house (or commodity) remains a bank asset—the bank is the landlord, and the client is the tenant. Over a period of time, the client pays a monthly amount, some of it goes towards the rent and some of it goes towards the purchase. Once the client has made enough payments to cover the original value of the house, the landlord (bank) transfers the property to the client (who then becomes the homeowner).

Many people permit this transaction. However, the scholars of Sunnah in general, disallow it. This and the next type of mortgage (Mushārakah) is what is referred to as “rent-to-own”. It has oppositions to Shareeʿah Law that render it harām:

1. A sale contract must have a complete transfer of property, whereas here the property remains the possession of the bank. The Islamic ruling is that ‘the seller has no right to maintain ownership after the item is sold.’ (Ruling of Majmaʿ al-Fiqh al-Islami, p. 110)
2. The contract has two transactions: sale and rent (lease) for the same commodity at the same time. These are two contradictory statements: a) rent implies that the property remains in the ownership of the bank, so the renter (tenant) cannot do as he pleases—he simply benefits from occupying it, b) the contract implies that the tenant owns the property as well.

Mushārakah (Partnership) Mortgage

Some financial institutions offer diminishing Mushārakah mortgages. This type of mortgage involves a partnership between the bank and the customer, where both parties contribute funds towards purchasing the property. The bank’s share represents their ownership, while the customer gradually buys out the bank’s share over time through regular payments. As the customer’s ownership increases, the bank’s ownership decreases until the customer becomes the sole owner of the property.

Here’s how it typically works:

1. The financial institution and the borrower enter into a partnership agreement. Both parties contribute funds to the partnership, with the aim of purchasing a property.
2. The property is purchased jointly using the funds contributed by both parties. The ownership of the property is shared between the financial institution and the borrower. The respective shares are agreed upon in advance and may not necessarily be equal.
3. The borrower then occupies the property and also pays rent to the financial institution for the portion that they do not own. The rent payments contribute to the financial institution’s share of ownership of the property.
4. Additionally, the borrower makes regular contributions towards buying out the financial institution’s share in the property. These contributions are treated as partial payments towards buying out the financial institution’s stake and increasing the borrower’s ownership.
5. Over time, as the borrower makes these contributions, their ownership stake in the property increases, and the financial institution’s stake decreases.
6. Once the borrower has purchased the financial institution’s share entirely, they become the sole owner of the property.

Some have permitted this transaction. However, others including the scholars of Sunnah in general, disallow it for the reasons stated previously: ‘rent-to-own’ is prohibited.

Late fees and interest when the borrower does not pay instalments on time

When a person falls behind on a payment, he is often forced to pay a late payment fee. This is prevalent in societies where the one who owes a debt but does not pay it on time, so he is charged an increased sum so that he can have more time (or because he took extra time to pay back) – this is ribā (usury or interest) and is strictly forbidden. This is the usury of the people of pre-Islamic ignorance – they would say to the one who owed the debt, “Either pay up [now] or pay interest!” So Allah forbade that and said instead, “And if the debtor is going through difficulties, then grant him time until it is easy for him to repay.” (Quran 2:280) There is a unanimous agreement (ijmāʿ) upon the forbiddance of every transaction that tries to make this increase permissible.

All praise is for Allah, the Lord of the worlds. May the peace and blessings of Allah be upon the noble Prophet, his family, his companions and all who truly follow him.