Islamic Mortgage

Under the Sharia law of Islam, the payment or receipt of riba (interest) is prohibited, and thus a conventional mortgage cannot be utilized by a practicing Muslim. Obviously this poses a problem, as home prices are far too expensive to buy outright for the typical consumer.

However, this can be solved by having the bank purchase the property and sell it back to the mortgagee in one of three ways. The bank will either sell the property at a higher price to the mortgagee under an installment plan, or rent it to the tenant/homeowner, and have the mortgagee pay a contribution towards the equity of the home each month until it is paid off in full. The second method is also known as “lease to purchase” because the homeowner “rents” the property while paying down principal and gaining equity. Another option is to create an LLC whereby the finance company and the homebuyer own shares.

With regard to the western world, Islamic Mortgages are probably most common in the United Kingdom, although they seem to be gaining steam in the United States. Roughly five years ago, mortgage financier Freddie Mac agreed to buy these types of mortgages, and at this point, others probably wish they had too.

Because Islamic mortgages tend to be more straightforward than some of the exotic offerings seen in traditional Alt-A and subprime lending, the borrower default rate is probably a lot lower.  The lack of trickery and bait-and-switch has also encouraged more Muslims to consider an Islamic mortgage, as it further justifies the choice.