Borrowing is still possible when interest is
banned by religious law
figures that he has paid enough rent in the past 20 years to have
bought several houses by now.
He didn't have much choice -- as an observant
Muslim, he takes seriously Islam's prohibition against paying or
receiving interest. That rules out a conventional mortgage.
Two years ago, the Silicon Valley telecommunications
engineer bought a house using interest-free financing, thanks to
one of the country's few funding sources that adhere to Islamic
In essence, he is renting to own -- and he
plans to own the house outright in about a year.
Haq belongs to Ameen
Housing Co-op, a kind of limited partnership comprising about
200 Muslims living in and around Palo Alto, Calif. In the cooperative's
four years of existence, 12 families have bought houses with its
"Given that we don't have too many options to buy
the house in an interest-free way, this was actually a very pleasant
experience for me personally," Haq says. "The only issue with Ameen
Housing Co-op is that they don't have enough money to go around for
a big backlog of people who are awaiting houses. I was fortunate to
be one of the early ones."
How it works
The following example is an oversimplification,
but will illustrate the concept:
Let's say you buy a house for $100,000 and make a $20,000
down payment. The lender (be it a finance company or a cooperative)
owns 80 percent and you own 20 percent. If the rental value
is $1,000 a month, you pay that amount, plus an extra sum
(let's say $300 a month).
With your first payment, $800 would go to the lender (80
percent of the rent because the lender holds 80 percent of
the value of the property) and $500 would be applied toward
your equity ($200 rent for the 20 percent stake you have in
the property, plus the $300 extra).
With each monthly payment, your equity increases and the
lender's share of ownership decreases, just as they do with
a regular mortgage. The difference is that the lender in an
Islamic-style loan does not enjoy a guaranteed rate of return;
instead, the profitability of the loan is affected by changes
in the housing and rental markets.
Payment amounts can be changed periodically to reflect fluctuations
in the rental market. Islamic lenders encourage borrowers
to repay as quickly as they can.
The quicker he pays off his loan, the quicker
another member of the co-op can move up in the waiting list and
buy a house.
Sharing the investment
Islam is the fastest-growing religion in the United States,
with an estimated 5 million to 10 million adherents. Its tenets
strictly ban interest. Instead, lenders are supposed to invest in
their clients' ventures and share in the profit or loss. For observant
Muslims in the United States, the ban on interest makes it tough
to buy a car and almost impossible to buy a house.
A few institutions have stepped into this void,
creating rent-to-own and lease agreements that satisfy religious
law, homeowners, car buyers and even the Internal Revenue Service.
There's Ameen, which as a cooperative shares
its profits and losses among its member investors. There's American
Finance House - LARIBA, a finance lender based in Pasadena,
Calif. A pioneer in interest-free financing for Muslims was Al Manzil,
a New York-based subsidiary of the Bank of Kuwait, which is withdrawing
from the U.S. market.
"The key difference between this and a traditional
mortgage is how the rate of return is calculated," says Mike Maguid
Abdelaaty, president of American Finance House - LARIBA. In a conventional
mortgage, the rate of return is the interest rate. In an interest-free
transaction that complies with Islamic law, "the rate of return
is based on the rental value of the home you are trying to buy."
Different, with similarities
All Islamic financing, whether the item being bought is a house,
vehicle or business equipment, follows this rental model. The lender
buys the property. The buyer then pays the lender the market monthly
rental value, plus an amount over that. The extra money and part
of the rent go toward buying out the lender's share in the property.
Eventually, the buyer owns the item outright.
From the buyer's perspective, the arrangement
doesn't differ all that much from a conventional mortgage: there
are the monthly payments, the paying down of the loan. From the
lender's perspective, Islamic financing carries more risk because
the arrangement is a joint investment. If the buyer decides to sell
the property before paying off the loan, the lender shares in the
profit or loss.
A trained person with a calculator can figure
the "imputed interest" -- what the buyer pays in the equivalent
of interest. When you run the numbers, this kind of financing costs
a little more than conventional loans, Abdelaaty says. Usually the
imputed rate is about 0.5 percent to 0.75 percent more.
Borrowers have been able to report the imputed
interest on their taxes. The IRS accepts the deduction, say officials
from American Finance and Ameen Housing Co-op. Humayun Sohel, secretary
of the Ameen board, says some borrowers don't take the deduction
because they want to steer clear of any hint of paying interest.
These financing contracts are usually for a
shorter period than conventional loans. Ameen loan papers usually
cite a repayment period of 10 years, but the co-op's members are
mainly Silicon Valley engineers who receive large bonuses and options,
so they typically repay the loans in three years. American Finance
House's customers pay off their loans in an average of six years.
About half of Islamic borrowers are immigrants
and half were born in the United States. They come from a
variety of backgrounds: African-American, Arab, Pakistani
and Iranian are among the most common. All share a common
tongue, Arabic, in religious matters.
Sharia: Islamic religious law.
Halal: Permitted for Muslims under
Haram: Not permitted for Muslims
Riba: Interest. Riba is haram.
Ijara wa iqtina: Rent to own, usually
of a house.
Demand exceeds supply
Abdelaaty says the market is just beginning to be tapped.
"The demand far exceeds the supply of financing,
definitely," he says. "Our estimates are that there's at least a
billion dollars of financing volume out there and no company has
even approached 10 percent of that yet."
Islamic lenders primarily are held back by
funding sources, he says: American Finance isn't a bank, so it can't
raise deposits. The same goes for its few competitors, the most
prominent of which is Houston-based MSI
Financial Service Corp.
These kinds of loans aren't available only
to Muslims. American Finance has lent money to non-Muslims. So far,
only Muslims have bought houses through Ameen, Sohel says, but he
believes Islamic-style financing might appeal to people of all faiths,
especially in rural areas where property values aren't appreciating
"If the message is taken to them, it might
be accepted," he says.
Haq, the man who is buying his house through
Ameen, agrees: "The idea has a lot of merit, even if I weren't a