Mortgage Q&A: “What is an Islamic mortgage?”
There are a variety of different types of home loans out there, some pretty conventional and some a little less so.
One you may have heard about, but might not be clear on is an “Islamic mortgage,” which as the name implies, is intended for someone of the Muslim faith.
If you’re wondering why a mortgage would need to be crafted based on someone’s religion, take note of the following.
Under the Sharia law of Islam, the payment or receipt of riba (also known as interest) is prohibited, and thus a conventional mortgage that charges interest each month cannot be utilized by a practicing Muslim.
Obviously, this poses a potential problem, as home prices are typically far too expensive to allow a prospective home buyer to purchase outright with cash.
However, this can be solved by having the bank purchase the property and sell it back to the mortgagor (borrower) in one of three ways.
The bank will either sell the property at a higher price to the borrower under an installment plan, or rent it to the tenant/homeowner, and have them pay a contribution toward the principal balance of the home each month until it is paid off in full.
The rent price is typically established by looking at comparable homes in the area where the subject property is located.
The second method is also known as “lease to purchase” because the homeowner “rents” the property while paying down principal and gaining home equity.
A final option is to create an LLC whereby the finance company and the home buyer own shares in the property.
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 as well.
In the early 2000s, mortgage financier Freddie Mac agreed to buy these types of “mortgages,” and at this point, others probably wish they had too.
Fannie Mae is also an investor in these types of loans, and in lieu of a mortgage, they become an investor in the property itself.
This allows smaller banks and mortgage lenders to offer the option and then sell it to Fannie or Freddie so they have funds to make new loans to future customers.
The lack of trickery and bait-and-switch has encouraged more Muslims to consider an Islamic mortgage, as it further justifies the choice.