Islamic Home Finance Methods

IJARA / IJARAH – Lease To Own
The term Ijara literally means rent, the Sharia process is known as Ijara-wa-Iqtina, rent with an acquisition or rent to own. The process of Ijara can be used for equipment as well as property. The process is very simple, a single asset Trust is created, the Trust purchases the property, and then leases the property to the customer. With each monthly payment, a portion of that payment goes towards ownership, until the customer owns 100%.

The basic difference between a Sharia Ijarah-wa-iqtinah process and a conventional lease is that, the Ijara process obligates the Trust (seller) to sell the property to you under a Promise to Purchase, and while the same contract entitles the customer to purchase the property, the customer is not enforceably obligated to do so.


The purchase price that is agreed to in the Promise to Purchase is equal to the original purchase price less the down payment made by the customer plus $1.00. For example, if the value of the property is $200,000 and the customer makes a $40,000 down payment, then the initial amount the customer has to pay the investor for 100% ownership is $160,001. As the customers ownership increases, this amount reduces, until the final ownership payment of $1.00

The initial Ijara amount that is financed by the customer, earns profit for the investor through monthly rental payments. Traditional amortization calculations are utilized to determine the exact monthly payment. The mathematical formulas are acceptable as there are no Sharia issues with mathematical calculations. The major difference between a traditional mortgage amortization and an Ijara transaction is that the Ijarah transaction is based upon a reverse amortization calculation.

While it may appear contrary to the Sharia, it is in fact acceptable to describe the profit on an Islamic transaction as a percentage. The following example should clear up any confusion regarding the acceptability of quoting the profit as a percentage in an Ijara transaction:

Suppose you have a $100,000 in cash.
You purchase a home and pay cash for the home.
You rent the home to a tenant for $500 per month
At the end of the year you have collected $500 x 12 or $6,000 in rent
That $6,000 in rent is a 6% return on your $100,000 investment
Is that 6% Rent or Riba? well it is clearly it is Rent, as it is based upon a business transaction. Now let’s look at a traditional mortgage interest transaction:

Starting with the same $100,000 cash.
You give someone the money.
They proceed to purchase the same home with those funds.
They pay you the same $500 per month, or 6% a year for use of the money.
This is basically rent on money
In this case is the 6% Riba? yes, it is rent on money. The first example was rent on property. So it should be clear that from a Sharia perspective it is acceptable to describe the profit on an Islamic Ijara transaction as a percentage. Furthermore, it is also a requirement under the Truth in Lending Act/Consumer Protection Act, that any profit earned on a residential real estate finance transaction should be described as a percentage so that a customer can clearly understand what the overall cost of the finance transaction is.

In an Ijara transaction, you are technically a tenant. You sign a lease that obligates you to a rent payment over a period of time. However, unlike a typical rental property lease, you are responsible for all the maintenance of the property, and you have all the rights and duties of a Homeowner. You can sell the property anytime you wish, you can remodel, decorate, landscape, sublet, or basically utilize the property for any legal purpose that it is zoned for. The only exception may be if you engage in an activity that may adversely affect the value of the property, like demolishing a garage without rebuilding it. For all practical purposes your role is the same as a homeowner, because once your have fulfilled your obligations under the lease or promise to purchase, you become the owner of the property.

One of the basic Sharia compliance principles is that there should be a sharing of either a gain or loss in a finance transaction. The Ijara transaction is structured in such a way that 100% of the gain is rightfully the customers. Under the Shariah, the gain or loss is shared by the parties in a transaction according to their percentages of ownership. The Ijara transaction abides by this principle, in that at the time of realization of the gain or loss, there is only one owner of the property, and that is the customer. From a procedural perspective, at the time of sale:

the Trust will transfer the title of the property to the customer,
the customer will then transfer the title to the new buyer,
the new buyer will then settle the transaction according to the agreement with the customer,
and then the customer will settle with the trust according to the agreement between the customer and the trust (the Ijara documents)
the procedural steps above creates a situation where the customer holds 100% title, albeit for a short period of time, but by doing so entitles the customer to be the beneficiary of the difference between the two agreements; that is the sale to the new buyer, and the original promise to purchase agreement with the trust.

MUSHARAKA – Declining Balance Co-ownership
The term Musharaka, Musharakah, means sharing. In the context of Islamic Finance, Musharak is a declining balance co-partnership, and is also a Shariah-compliant method of Islamic Home Finance.

You enter a partnership arrangement with a co-owner and sign a contract that specifies the terms of your agreement. After you find the home you want, you get approval to move ahead, and make an offer. Your partner or co-owner, usually a professional investment company rather than an individual, provides the lion’s share of the purchase price.

As part of the partnership agreement, you agree to make monthly payments to the partnership for your use of the home as either explicit or implicit rent.. At the same time, you make regularly scheduled investments in the partnership to increase your equity, or ownership share, of the home. With each payment, the balance you owe the partnership declines and your equity increases.

The amount of your monthly payment is determined at the time of purchase, based on several factors including the price of the home, your credit rating, the amount of your initial payment, the term of the contract, and the current and projected fair market value of similar homes in the community where you buy.

Shariah scholars are working with Islamic financial institutions to make the monthly payment schedules more like conventional mortgage amortization, indicating how each payment is divided. The goal is to make the contracts easier to understand and ultimately more available at competitive prices.


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