Islamic-style mortgages approved in Minnesota

images29Last month the Minnesota Housing Finance Agency approved its first mortgage that complies with Islamic law. The new homeowner, an American of Somali descent, had wanted to buy a house for years but did not because parts of the Quran are interpreted to mean that Muslims are forbidden from taking or paying interest on loans.

Now, before you begin to fantasize about student loan payments sans interest, it is important to emphasize that this new homeowner’s payments are exactly the same as they would have been had he taken out a regular 30-year mortgage. It is simply the structure that is different.

Rather than borrowing money from a bank with a lien on the house guaranteeing repayment, the bank bought the house from the seller and resold it to the “borrower” at a profit. This is called a murabaha agreement, and it is probably the most straightforward of Islamic mortgages. Another type resembles a rent-to-own, while a third involves the home buyer and the bank forming a company, which owns the house, and the home buyer gradually buys out the bank’s share in the company.

(A brief word on terminology. An old Muslim consultant whom I was begging for a job once lectured me for forty-five minutes on how there are no borrowers in Islamic finance. “There are only partnerships!” he said. Well, he never gave me a job so I’m going to call them borrowers, with all the normal caveats about its legal inadequacy.)

All Islamic mortgages do essentially the same thing: they imitate interest without actually charging it. Leaving aside the religious sensibilities of American Muslims, this process raises several important questions. Can the borrower claim the mortgage interest deduction? If he defaulted, would he be eligible for a bailout under the Obama (or any other) plan? Most importantly, why should the Minnesota Housing Finance Agency—a state owned bureau—want to do this?

The answers to the first two questions are unclear. The IRS has not published any guidance on the matter and seems to accept deductions on Islamic mortgages; indeed Professor Roberta Mann at the University of Oregon argues that the government ought to revisit the mortgage interest deduction to ensure that there is no discrimination in either direction. Certainly the MHFA ought to clarify their recommendations on the matter before this program becomes very large.

The larger issue, however, is the separation of religion and state. While Islamic mortgages are open to anyone, it says right there on the contract that the murabaha agreement is an “attempt to arrange the purchase of the Property in accordance with the Shari’a approved Islamic precepts.” On the surface that’s troublesome (and were I the MHFA’s lawyer I might have worded it differently), but consider what these contracts do. Rather than restricting mortgages, they attempt to expand homeownership to a whole new class of Americans. That’s an admirable goal, and assuming the Islamic mortgages are made to otherwise qualified borrowers, it’s hard to see a downside.

Homeownership gives a person a stake in society, an added incentive to see one’s community and country to do well. That was underlying assumption behind Clinton’s expansion of the Community Reinvestment Act and Bush’s “ownership society.” Rather than discriminating against non-Muslims—as some will no doubt argue—Islamic mortgages help make Muslim immigrant populations economically and socially more American.

On top of that, the structure of Islamic mortgages makes them difficult to refinance—so at least we don’t have to worry about a Shari’a housing bubble in Minnesota.

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