A History of Islamic Finance in America

Every American has a right to participate in economic society, to own a home, and to achieve their long-term dreams. And they also have a right to practice their faith to the best of their ability which, in many cases, means abstaining from participation in any interest-based forms of financing.

As interest is built into the Western financial system, this has created a unique set of conflicts for American Muslims — at least until the recent emergence of faith-friendly financing, which began about 50 years ago and has expanded ever since. 

Muslim entrepreneurs and nonprofits often found themselves forced to assemble all needed capital before starting a project or launching a business, and many faith-conscious Muslim families found way to obtain mortgage financing that is consistent with their religious beliefs.

In response to this ongoing need, new forms of faith-friendly financing have emerged. Despite Islam’s general prohibition against interest-bearing loans (a term that describes most mortgages issued in the United States), it is now possible for many Muslims to ethically purchase a home with more money than they currently possess. Achieving the American Dream of homeownership and adhering to the basic tenets of Islam is more possible than ever before. 

In this comprehensive guide, we will discuss the most important things to know about Islamic finance, including what it is and how it can help Muslims faithfully secure major purchases.  

What Is Islamic Finance? 

When compared to traditional finance, Islamic finance avoids the use of interest and instead offers halal alternatives. 

Islamic finance is a well-defined set of financial practices that are specifically chosen to be compliant with Islamic law (Shariah). This particular set of practices is designed to help Muslims achieve long-term financial goals such as owning a home without having to directly participate in any practices that contradict Islamic principles, such as charging or paying interest. 

Using Money for Good

For as long as money has existed, it has been a consistent enabler of both prosperity and conflict. Money can be used as a medium of exchange that can serve to benefit people. But in the worst of times, money can contribute to problems including war, corruption, exploitation, and more. 

For better or for worse, money has become a permanent component of the international economic system. But how this resource can be used effectively — while avoiding its pitfalls — remains an ongoing matter of debate. Many world religions have consistently warned about the risks presented by the use of money, particularly, usury, or the act of collecting interest. Islam has played a pivotal role in this broader, global conversation. 

Interest in Islam

Ultimately, everyone who participates in the economic system must decide their personal ethics regarding the use of money, borrowing, and the collection of interest. Interest-based financing is something Islamic scholars say should be avoided altogether. In the Quran, the collection of and participation in the use of usury is something that, in nearly all cases, is morally unacceptable. 

In the modern world, this has created a unique set of challenges for many Muslims inside the Middle East and Islamic countries but even more so for those living in western countries. The United States is heavily reliant on the use of interest-collecting financial institutions for mortgages, credit cards, and other types of financing. 

Islamic finance and Islamic banking are like many other socially responsible investment structures; there is a large group of people (more than 7 million in North America) who have a specific set of needs and values, and financial institutions have adjusted themselves accordingly. Through the general use of Islamic finance, it has become possible for Muslims to make large-scale investments while also avoiding the use of interest.

What Makes Islamic Finance Different? 

The principles of Islamic finance are rooted in the teachings of the Quran and the Prophet Muhammad. There are quite a few differences between Islamic financing and traditional financing.

The Difference Between Islamic Financing and Traditional Financing 

Islamic scholars have outlined several principles that should be present for a transaction to be permissible. Here are a few of those principles:

  • Investments in industries deemed harmful to society, such as alcohol, tobacco, and gambling, are prohibited.
  • All parties involved in a financial transaction should share the actual profit or loss of a venture.
  • Islamic law does not recognize money and money instruments as a commodity, so returns must be tied to a real asset.
  • Riba, or usury, is prohibited.

One of the most important differences between Islamic financing and traditional financing is the charging of interest on a mortgage. With many conventional financing options, homeowners will often end up paying more money in interest over the course of 30 years than they do for the home itself. Charging interest on home purchases is a huge component of the traditional mortgage system.

Islamic sharia law explicitly forbids the charging of interest. Therefore, any faith-based Islamic financing products that can be considered halal will avoid the incorporation of interest.

The History of Islamic Finance 

Trade and profit are permissible in Islam, but the Quran clearly bans interest.

“Allah has permitted trade and has forbidden Riba.” (Quran 2:275)

When translated into English, riba typically means interest, excess, or usury.

Islam and other monotheistic religions consider the use of any type of interest to be exploitive, just as most people currently consider the use of “payday loans” and other forms of excessive interest-bearing financing to be exploitive for consumers today. 

The primary focus of the Islamic prohibition of usury, or riba, has been justice. While it might seem as if borrowing with interest can be temporarily beneficial for many people, the ultimate consequence of participating in this system is injustice — the rich see vast growth in their wealth as a result of taking advantage of those who are in need, while the poor become relatively poorer due to the broader expansion and corruption of the debt and monetary system. 

Looking for Alternatives

The issue of the use of riba has been revisited many times throughout Islamic and global economic history. In the 1970s, there was a considerable revival of the broader dialogue regarding riba throughout the Muslim world. This was a period where the existence of the “global financial system” was seemingly unavoidable, but many Muslims began looking for alternative options for investment and daily finance. 

Following a series of several international Conferences on Islamic Banking, Muslims had their first genuine opportunity to establish an interest-free banking community. These conferences were critical not only for people living in Muslim-majority nation but especially for Muslim minorities living in the U.S., UK, and elsewhere throughout the world. 

During these conferences, scholars were in agreement that the collecting or paying interest was considered riba (which is haram, or forbidden by Islamic Law). As a result, it appeared that any middle-class Muslim who wanted to secure a mortgage while maintaining their adherence to principles of Islamic law would need to look outside of the traditional mortgage system. 

Emergence of Islamic Options

Over the next few decades, the emergence of Islamic Banking would gain quite a bit of traction in the west. The need for alternative banking options was especially high in countries, including the U.S. and UK, that had fast-growing Muslim populations. While this transformation was gradual, it was still very important.

Today, Muslims can now ethically finance major purchases such as mortgages while also maintaining their faith and adhering to the prohibition of interest. Islamic financing products include commercial real estate financing, construction financing, and secured lines of credit. These financing products are created to remove barriers to accessing capital for Muslim entrepreneurs and nonprofits. Islamic finance operates under the supervision of Sharia boards, panels of scholars who ensure compliance with Islamic law.

This has represented a major transformation in the global banking system, as well as a significant movement towards justice. Islamic finance is part of a broader movement toward ethical and socially responsible investing, appealing to a wider audience beyond Muslims.

What Principles Are the Islamic Economic and Financial System Built On? 

As suggested, the general wariness against the use of interest (usury) is not exclusive to Islam; in fact, most global belief systems generally discourage excessive or exploitive borrowing, even though this level of discouragement is much clearer for followers of Islam than it is for followers of other belief systems.  

The book “Debt: The First 5000 Years” by David Graeber helps illustrate how the issuance and collection of debt have been an exploitive practice among nearly all cultures, dating back to the near-beginning of written history. To Muslims, accumulating debt and the exploitation of interest is something that ought to be avoided, even if it might be necessary for the most extreme circumstances.

In other words, most faith-conscious Muslims would probably have at least some problems with the current interest-based financial system, regardless of whether or not they are compliant with the general principles of Shariah. But for many Muslims, the need to avoid this structurally exploitive system is even more important.

There are several basic underlying principles that underscore the need to reject the use of interest: 

  • Any harmful activities need to be avoided: The Quran forbids many activities that contain more harm than good for people. Some of the most notable haram activities include the consumption of alcohol and pork-based products. The use of interest is also haram. This means that, at least for Muslims, interest-bearing loans should be avoided to the greatest extent possible. 
  • Financial Risk Needs to be Shared: In the “traditional” financial system, risk is typically not generally held by the large banks that are issuing the loans; instead it is held almost entirely by the borrowers. This creates a structurally unequal and exploitive playing field. But in a Shariah-compliant lending system, the risk will be shared by all parties involved. 
  • Wealth Must Come from Legitimate Activity: if a person or organization is to increase their wealth, it must come from financial activities that are both halal and just, and trade must be asset-backed. People who work for money and people who engage in legitimate trade, halal small businesses, and halal investing can consider their wealth to come from a halal source.
  • Justice is the Ultimate Goal: in the end, all of these crucial principles have a basic underlying goal: justice.

With more ethical and equitable options, more people would be able to become genuine homeowners, more people would be able to achieve the American Dream, and more people would be able to manage their monthly finances.

These financial transactions are structured quite a bit differently, but they all allow businesses to earn a profit through more equitable methods while allowing consumers to purchase real estate without needing all the funds upfront.

Three Models of Islamic Financing

In the murabaha model of Islamic financing, the bank or financier buys the home and sells it to the customer at a marked-up price, to be paid over time. This avoids interest, but a downside is that this practice does not include the principle of risk sharing, which is an important principle in Islamic finance.

In the ijara model, the financier buys the property and rents it to the homebuyer, with a portion of the payment going toward the purchase of the property. A downside of this model is that the homebuyer does not own the property until the contract term is complete, often 30 years later.

In the musharaka model, the financier will buy the home together with the homebuyer. Rather than paying interest, the homebuyer will continue buying a larger portion of their home from their original financing partner until, eventually, they own the entire property. In this partnership-based model, the homeowner enjoys ownership rights from the beginning, and risk is shared between the two parties. In most cases, this equitable model is the most suitable in the West, and it’s the one Guidance Residential uses.

Common Misconceptions About Islamic Finance 

While many people know about the existence of Islamic finance, many misconceptions still exist. Here are a few of the most common misconceptions about the Islamic financial system, which might be relevant to both Muslims and non-Muslims alike. 

  • The experience of acquiring an Islamic-financed loan will be much different than acquiring a traditional loan: There are clear differences between Islamic and traditional financing—especially regarding the general use of interest. However, contrary to what many assume, the experience for the homebuyer is not that different. Both methods involve financing a home and setting up a payment structure. However, what makes both Islamic banking and Islamic financing unique is that the Islamic system avoids interest and, therefore, is compliant with Islamic principles. 
  • The only people who can apply for an Islamic-financed mortgage are Muslims: While these mortgages are designed for the Muslim community, they are available to everyone—regardless of their faith. This more equitable method of financing is growing in popularity among the broader community as well.
  • Islamic financing is exceptionally complicated: It is clear that Islamic financing is different from traditional financing. But that doesn’t mean the process needs to be more complicated. In fact, depending on the financier, it can be even more streamlined and accessible.
  • Islamic financing costs more than traditional financing: While initially Islamic finance cost more than a traditional mortgage, this is no longer the case. Halal mortgages are now competitive with traditional loans.
  • Islamic financing is uncompetitive in the current marketplace: It might be easy to assume that Islamic financing, which is more ethics-focused, can’t compete in the current environment. But it is indeed competing—and growing.

Why Is Islamic Finance Important? 

For many Muslims, the code of ethics outlined in the Quran is guidance for their daily life. Something prohibited in the Quran needs to be avoided to the greatest extent possible. 

In a country that is founded upon the principle of freedom of religion, like the U.S., this means that Islamic financing is not something that should be considered a “niche” component of the financial system, but one that is made readily available. 

Ready to Look Into Islamic Financing?

Buying a home is one of the most important decisions you will make. The team at Guidance Residential is here for you every step of the way, from pre-qualification and pre-approval on through to finding the right real estate agent for you and your family. We invite you to explore the home buying process with Guidance Residential today.

Guidance Residential remains the #1 U.S. Islamic home financing provider. Over the past 20 years, we have assisted more than 40,000 families. Learn more and get started on your home finance journey today.

Your Guidance Residential Account Executive is here to help with any questions. Looking to refinance or purchase? Have a friend or family member who is looking for a home? Call 1.866.Guidance, or start an application today.

Updated in November 2025.

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