10 Common Questions about Buying a House the Halal Way
Adam and Sarah are new home buyers who plan to purchase a home this year. They want to achieve the American dream of home ownership. They are also devout Muslims who wish to finance their home in a way that upholds the principles of their faith, but they wonder if that’s possible.
That’s because the couple know their faith forbids them from giving or receiving interest, otherwise known to Muslims as Riba or Usury. They know a conventional mortgage is based entirely on interest, but they don’t see another option other than continuing to rent. And they don’t want to rent anymore — they want stability for their children, and they feel like they’re throwing away money that could be an investment for their future.
In searching for a solution, Adam spoke with a friend who mentioned Islamic Home Financing or Shariah-Compliant Home Financing. For the first time, they realized that as American Muslims, it IS possible to own their home in a strictly halal way without violating the laws of their faith.
There are many American Muslim families like Adam and Sarah who have similar questions. In order to provide a better understanding of the process, here are the 10 most commonly asked questions about Islamic Home Financing from potential home buyers. Read on to learn more about Guidance Residential’s Declining Balance Co-ownership Program – a program approved by leading Shariah scholars of the world and endorsed as a permissible way to home ownership for American Muslims.
The Top 10 Questions about Halal Mortgages — Answered
1. What is Shariah-Compliant Home Financing?
Shariah-compliant home financing is a form of financing a home in a way that follows the principles of Islamic law related to financial contracts set by the rules and injunctions from the Quran and Sunnah. To protect individuals and the community they live in, Islam prohibits Riba (usury/interest), Gharar (speculation or contractual uncertainty), and Maysir (gambling). With those guidelines to follow, Muslims adhering to their faith find that traditional mortgages are not an acceptable option.
When financing a home using a conventional mortgage, the borrower must pay interest (Riba), which is prohibited in Islam and all monotheistic and even some non-monotheistic faiths. Guidance Residential’s Shariah-compliant home financing program does not involve Riba. The Declining Balance Co-ownership model of Guidance Residential is a participatory financing program, which is based on an equity partnership between Guidance and the customer. The unique differentiating factors between Guidance Residential’s program and a conventional mortgage are as follows:
Rather than a borrower-lender arrangement, in Guidance Residential’s approach to home financing, Guidance Residential and the customer each own a percentage of the property as co-owners. This co-ownership relationship is inherently more equitable from the foundation up.
In the co-ownership model, Guidance and the customer buy a home together. Each month, the customer pays Guidance a payment that consists of two parts. One part is a Profit Payment covering the customer’s use of Guidance’s share of the home. The rest goes toward buying out Guidance’s share of the home. Over time, Guidance’s share decreases as the customer’s share increases until the customer is the sole owner of the home.
The co-ownership model means that the customer is not a debtor but rather a valued partner. What a difference!
In a traditional mortgage, the bank or lender naturally protects itself carefully while the customer bears nearly all of the risk involved in the home purchase. In a co-ownership arrangement, other the other hand, Guidance Residential shares the risk with the home buyer in certain instances of loss. These instances can include natural disasters, condemnation or eminent domain. That’s because the home purchase is essentially a joint investment in which risks and profits are shared according to various common-sense guidelines. However, it should be noted that if the home is sold for a profit, that profit belongs solely to the homeowner. It’s a win-win for the customer.
The Declining Balance Co-ownership Program, does not involve payment of interest between a debtor and creditor – it is 100% Riba-free.
Riba, or interest, is strictly prohibited in Islam. A loan is intended to be a form of charity in which one person helps another. The lender should expect repayment only of the amount paid — no profit.
In Islamic finance, a company is allowed to profit in different ways, and the customer pays Guidance a fee for using the company’s share of the home they purchased together. It is acceptable for that fee to be competitive and comparable with a traditional home mortgage for the sake of simplicity. But the fees paid by Guidance’s customers are entirely different from riba.
No prepayment penalty
In a conventional mortgage, if the homeowner decides to pay off the home early, the bank loses out on interest that would have been paid, so it has historically been customary for the bank to charge what is called a prepayment penalty to offset that loss.
Guidance Residential, on the other hand, does not charge any fee if you decide to pay ahead of the agreed schedule. Instead of charging a prepayment penalty, we are happy for you and wish you the best!
Capped late payment fees
In a conventional mortgage, when a payment is late, the bank immediately charges late penalties that often equal about 5% of the payment owed. On a $2,500 mortgage payment, that would mean paying an extra $125 each month you are late — presumably when you are already facing hardship. Only a portion of that late fee goes to the administrative expenses of reaching out to you for the payment; the rest is profit. In other words, the bank benefits from your hardship.
With Guidance Residential, if you make a payment late, we charge only a capped fee equaling $50 or less, exclusively meant to cover the expenses involved in administering a late payment. We do not profit from your hardship.
Default and foreclosure
If a homeowner is unable to continue paying for their home and begins to default on payments, foreclosure may be inevitable and the home will be sold in an attempt to recover the cost. In the case of a conventional mortgage, if the home sale doesn’t cover the amount you owe the bank, in many states the bank or lender will go to court in an attempt to seize your personal assets to pay the difference. Not only does the customer lose the home, they could also lose the contents of a bank account or their car.
At Guidance Residential, we don’t do that. If the proceeds from the home’s sale do not cover our portion of the property, we do not pursue our customers’ personal assets. The only asset that can be taken back in the case of foreclosure according to Islamic financial guidelines is the one that was purchased. The buyer is safe from having anything else taken to repay the loss.
2. How does the Declining Balance Co-Ownership Program Work?
Guidance Residential partners with the home buyer in a co-ownership venture: Each party owns a percentage of the home in proportion to the equity they contribute. Home buyers are required to make monthly payments to Guidance Residential over a predetermined period of time in order to completely buy out Guidance Residential’s shares in the property and become the sole owner.
The monthly payment consists of two portions:
- An amount for the acquisition of a portion of Guidance Residential’s ownership interest (Acquisition Payment). The Acquisition Payment serves to purchase Guidance Residential’s shares of ownership over the predetermined period of time.
- An amount for the exclusive use of the entire property (Profit Payment). The Profit Payment serves to allow the home buyer to use the part of the property owned by Guidance.
For example: If a client wishes to purchase a $300,000 home and has $30,000 for a down payment, Guidance will contribute the remaining $270,000 in funds to purchase the home together forming a co-ownership arrangement. The co-ownership agreement is set up on a 15, 20, or 30-year contract in which monthly payments are made to Guidance Residential. In accordance with the terms of the co-ownership agreement, the home buyer can sell the property at any time, and any profit from that sale will belong to them alone.
3. What is the role of Freddie Mac in the program?
Scholars of Islamic financial law have confirmed that it is permissible for Guidance to introduce other investors to take a co-ownership stake in a given property. In doing so, our objective is to continue to service our customers’ needs to their satisfaction and to ensure that investors will always be bound by their rights and obligations as co-owners in the property.
Freddie Mac falls under this category of additional investors that allow us to better serve our customers. Freddie Mac is a federally mandated institution chartered by Congress in 1970, to provide funds for home financing companies in order to promote and advance the American dream of home ownership.
For properties financed by Guidance Residential’s Co-ownership Program, Guidance sells its co-ownership stake to Freddie Mac, who then becomes an investor. Guidance continues to be the party to administer the agreement with the customer in accordance with Islamic financial guidelines. This collaborative effort, with all terms agreed upon in the co-ownership agreement remaining unchanged throughout the duration of the contract, is approved by the Shariah Supervisory Board.
Guidance Residential worked with Freddie Mac and 18 law firms for three years to create a unique legal structure that does not involve the sale of debt and is compliant with Islamic legal jurisprudence. Guidance is the only organization in the U.S. allowed to deliver the Declining Balance Co-ownership structure to Freddie Mac.
4. How is the Declining Co-Ownership Program different from conventional mortgage loans?
In order to be an acceptable method for commerce according to Islam, a home financing program must be modeled after one of several permissible Islamic financing concepts. The most suitable of these for home financing in America is known as “Musharakah Mutanaqisa” or “Diminishing Partnership,” so that’s the approach Guidance chose in developing our home financing program.
The relationship between Guidance Residential and the home buyer is that of co-owners in a property and not that of a borrower-lender. The initial financing provided by Guidance Residential is applied to acquire a share of the property and not to provide a loan. The entire foundation of Guidance’s home financing is different from that of a conventional mortgage loan.
5. What makes Guidance’s program halal?
First, Guidance’s program is free of riba. It is based on a business partnership rather than a loan.
Secondly, it an asset-backed transaction as required under Islamic law, rather than essentially the purchase of money for more money, as is the case with a traditional mortgage loan.
Third, it was developed with the help of Islamic scholars and based on an accepted model of financing under Islamic law.
Fourth, it is unique in that it utilizes a globally renowned board comprising seven of the leading scholars in the world of Islamic Finance to ensure that its initiatives continue to be Shariah-compliant as well as compliant with each individual state’s laws.
6. Is Islamic finance for Muslims only?
Not at all!. The Islamic home financing program at Guidance Residential welcomes people from any community and faith to take advantage of this ethical and responsible way of home ownership. This approach not only fulfils the obligation of all monotheistic faiths, but also benefits the economy with a just form of financial transaction based on real assets. Read more here.
7. Can a home be purchased with less than 20% down payment?
Yes. Guidance Residential customers can make a down payment as little as 5% for primary homes and 15% for investment properties. In fact, the notion that a halal mortgage is more expensive than a conventional mortgage is a myth. Use this Islamic home financing calculator to review estimated payment outcomes.
8. Have you renamed “interest” as “halal financing”?
No. Interest is charged on a loan, and profit is charged for a tangible good or service. At Guidance Residential the contract is not a loan contract, but an equity partnership contract related to a tangible asset – the home.
While we have structured our program externally to look similar to that of a mortgage for the sake of simplicity for our customers and regulators, the entire foundation is different from a loan. As a comparison, two bags of potato chips might look the same on the outside and cost the same, while one is made with lard and the other is cooked in vegetable oil. One is halal while the other is not. Still wondering if Guidance Residential’s financing options are really halal? Check out this article.
9. Why do Islamic financial institutions need credit scores?
In the early days of Islam, investors would inquire about a potential partner’s history of doing business before entering in a contract in order to determine whether the partner was able to fulfill the trust (amanah) of the financial transaction (in modern jargon, financial industry calls it “credit worthiness”). In current business practice, a credit score serves as a standardized method of determining that worthiness.
10. Is Islamic financing more expensive than conventional mortgages?
Not anymore. Guidance Residential’s objective is not just to offer Shariah-compliant home financing, but also to provide it at a competitive price (not to mention a top-notch customer experience). Guidance’s website provides our current rates for comparison. Not to mention the other benefits that save you money compared to a traditional mortgage.
Learn more about Islamic home financing: