What is an Islamic mortgage?

An image of two hands shaking like a business deal

At Guidance Residential, we sometimes get asked this question: “What is an Islamic mortgage?”

The short answer is that while Islamic home financing might look like a mortgage, it isn’t actually one.

A traditional mortgage works this way:

You decide to buy a home. A mortgage company gives you a loan—basically selling you money for more money. You pay them back every month. Part of your payment goes toward what you owe for the house, and another part (the biggest part) is the interest you pay the mortgage company for the loan.

In this scenario, you take on 100% of the burden and 100% of the risk. If you fall victim to a natural disaster or eminent domain, you’re left to deal with it on your own. If you lose a job and miss a payment, the mortgage company charges you compounding fees, profiting off of your difficulties. Eventually, they’ll take the home, leaving you with nothing.

If, on the other hand, you find that you can pay extra to save on interest, they may charge you a penalty for paying them early.
Islamic home financing works differently.

Guidance Residential’s model works like this:

You decide to buy a home. Guidance buys it with you. You co-own the house together with us. Every month, you pay a certain amount to Guidance to buy a little more of the house from us. You also pay a usage fee each month, similar to a rental fee, for full usage of the home since you are the one who is actually using the house—you’re living in it. Both of these fees are combined into one monthly payment. Over time you buy out Guidance Residential’s stake in the house, and it is yours alone.

In this scenario, we are sharing the burden with you AND sharing the risk. If you miss a payment, we don’t profit from your difficulties. Guidance charges a small fee to cover the administrative cost of sending reminders, but it never compounds. In the event of default, when the home is sold, Guidance will only reclaim its share. In the event of a natural disaster or eminent domain, Guidance will share the loss in proportion to our ownership stake. And you can buy out Guidance’s shares at any time without a prepayment penalty.

In one sense, the two approaches look similar, because you are sending off payment each month in return for a house. But the mechanism is very different.

“They have nothing to lose – they get every benefit you get in the conventional banking system, plus unique benefits,” says Guidance Residential Regional Manager Salman Ali. “We share in the loss in case of natural disaster, eminent domain, foreclosures. These are unique benefits that nobody else offers in America.”