Mortgage

by Jamal Badawi
reprinted from Islam Horizons May/June 1996

Like any other human being, Muslims also need and desire a secure dwelling for themselves and their families. Until 1975, owning a home was an unthinkable proposition for practicing Muslims, because usury is prohibited by Islam. The Qur'an (2:276) says: " Allah has permitted trade and forbidden usury," and in 2:278 reminds the Muslims: "O ye who believe, keep your duty to Allah and relinquish what remains (due) from interest, if you are believers."

The Prophet (salla Allahu alaihi wa sallam) forbade usury. One of the better-known ahadith, narrated by Ibn Mas'ud, quotes the Messenger of Allah (salla Allahu alaihi wa sallam), saying, "Allah has cursed the receiver, the giver of the interest and a lso the witness and the scribe of the interest- bearing transaction; they are alike." (Muslim, Tirmidhi).

The seed of interest-free mortgages was planted in 1975 when a group of Muslims based in Halifax, Nova Scotia, Canada drafted the first working document. The precursor to today's Islamic housing finance deeds was a simple two-page document that spelled out the shared equity and rental terms. The first home financed under these terms in Halifax was paid off within three years. Although the originators of this idea worked hard, they could not reach a wider audience.

The concept of interest-free housing finance is still unknown in the west, thus the term "mortgage" is used here in the sense of collateral and as having the title of the property in the names of those who provide the funds.

The need for such financing became more acute when interest rates shot to nearly 20 percent in 1982. As a result several Muslims lost their homes. Thus the idea of the Shared Equity Rental (SER) was revived.

The original document was refined, expanded, and then promoted through a cable television program. It soon caught the attention of a regional station of the Canadian Broadcasting Corporation (CBC). Later on the idea was disseminated through the Islamic Teaching Series audiotapes. Not long after, a housing cooperative was established in Toronto. This venture has now emerged as the most successful Muslim financial establishment and has financed more than 200 homes so far.

The financing idea was analogous to a business partnership in which several partners would pool their money. Suppose a seven person group came up with $70,000 ($10,000 each). If, after one year, one of them wanted to withdraw, he would be entitled to the value of the business in this case the net worth at the end of the first year. The same concept was applied to housing, taking into account the additional element of rent, assuming that either: a) the person is a first-time buyer of a house, or 2) the person is homeowner wishing to convert an interest-bearing loan into a halal mortgage. In the first situation, suppose the fair market value of the house is $50,000 and that it is shared by 50 equal partners. In the second situation, let us assume that the homeowner owes and that 40 shareholders are available to assume the mortgage. The property is transferred to this partnership.

The issue of rent can be understood by using a simple model that involves five shareholders each investing $10,000, who decide to rent the house to one of their partners. The rent is determined by the fair market rental value of the house, which maybe assumed to be $450 per month or $5,400 per year, while taxes and maintenance come to $900 per year. This will leave $4,500 (i.e. $5,400-$900) to be divided among the holders of the 50 shares. In other words it will produce an income of $90 per share. However, the ten ant also holds one-fifth of the equity in the property; thus this is deducted from $4,500 and the remaining $3,600 is distributed among the holders of 40 shares.

If the person continues to pay rent alone, he would never own the house. Therefore, he is allowed to buy back the shares of his partners to increase his equity and eventually buy the property. At the time of the purchase, the price of each share was assumed to be $1,000. it may be assumed that the price remains unchanged throughout the first year. If, after the end of the first year, the tenant is required to buy back three additional shares at $3,000 and adds to this sum the investors' share of they early rental ($3,000), this gives a total of $6,000 which is the basis for determining the rent for the second year: $550 per month ($6,600/12).

In order to account for the appreciation in property value, it may be assumed that, by the next year, the value will rise by 10 percent. Now the house is worth $55,000, and the price of each share is $1,100. This appreciation changes the rental as well, which, say, increases by 10 percent to $5,940 per year. Out of this $990 (also up 10 percent) and the total rental of $4,950 per year, an income of $99 per share is produced. During this period, the tenant's shareholding has risen to 13shares,which means his equity is 13/50 and his earnings are $1,287 (i.e. , $99 x 13). This leaves $3,663 to be shared among the remaining four investors, who hold 37 shares.

In the second year, if the tenant wants to buy three more shares at the current price of $1,100 per share, he will have to add $3,300 to the rent and the total year's rent will be $6,963 with a monthly rent of $580. Under this formula, a person would own the house in 14 years, allowing a 10 percent annual increase in property value. The additional payment that the buyer has to make ($550 the first year, $580 the second year, and so on) every year during this period results in five to six percent average increase in the monthly rental, which is most reasonable. However, the increase (or decrease), can be based on the policy of the tenancy boards or market trends.

In case a person is unable to pay the increased rent in the following years, then he can opt to either acquire no new shares or fewer shares in the property in subsequent years. However, it is better to speed up the payments even at higher monthly payment, because then ownership can be gained in a shorter period of time.

The fair market value of the property can be determined by an appraiser, or, if the partners agree, through calculating the average price assessed by an agreed number of appraisers. In order to provide legal guarantees to all parties, a mortgage document can be prepared by modifying the documentation of interest-based mortgages. In the first such transaction in Halifax, the documents were processed like any other mortgage documents. The document spelled out all details related to the expenses, where it was assumed that the investors were buying a property, and renting it out for profit. Thus, the property taxes, insurance, and maintenance were considered qualified expenses while such incidentals as lawn care, snow removal or utilities were expenses to be paid by the tenant.

If the tenant wanted to make improvements to the property, say add a swimming pool, he had to approach the investors. If they agreed, they could acquire additional shares in return for financing these improvements. Or, they could ask the tenant to pay for the improvements with the stipulation that the next property appraisal would exclude these improvements.

In view of Canadian tax laws, it was decided that investors would report any income as rental income less expenses. Such reporting was audited and accepted by the tax authorities. There was no problem of capital gains tax, because documentation of a regular mortgage was used where the gain was on paper (and was reported) with no actual transfer of property. This was not challenged by the taxation authority.

If the tenant-buyer has to move, the property can be appraised to give him his share, and the remaining owners can find a new tenant-buyer or sell off the property and share the proceeds.

This arrangement helps to avoid riba while enabling a Muslim to own a home. The payment schedule is flexible and can be modified to suit both parties, the buyer and the investors. This encourages many others to purchase shares so they can buy property later. The model was developed with the intent of encouraging the tenant-buyer to speed up his payments, as it was advantageous to buy back and acquire full ownership.

The cooperative housing program helps those Muslims who need financial help to purchase a home, while helping to generate income for the investors from the rent and shares in the appreciation of the property's value. In the Toronto housing cooperative , the appreciation is calculated at the time of closing of the mortgage (through full buy back of the share, or due to sale for any other reason). The appreciated value is divided among the owner (the mortgagee) and the housing cooperative according to th e agreed upon ratio, where 90 percent goes to the homeowner and 10 percent to the cooperative.

In subsequent years, refinements were made by other cooperatives such as the Muslim Savings and Investments (now known as MSI Finance, Inc.) which floated its SHARE (Shared Home Appreciation in Rent and Equity) in 1989, and a similar venture in Melbourne, Australia. Other housing cooperatives such as the Bait al Maal al Islami (BMI), Islamic Cooperative Housing Corporation of St. Louis, MO, and the Qurtaba Housing Cooperative of Montreal, Quebec, Canada, are also busy in this areas of Islamic financing.