The Problem: For devout Muslims, Sharia law prohibits mortgages because of the prohibitions on interest and unequally shared risk. The Ijara-wa-Iqtina (lease and ownership) process allows Muslims to create a rent-to-own agreement in which the home’s inhabitant becomes a renter, thus abiding by Sharia principles.
The Solution: The Ijara process is asset-based rather than credit-based Islamic financing method that has been used in the U.S. for more than 20 years. Similar to conventional auto leases, the Ijara loan sets up a lessor-lessee relationship rather than a creditor-debtor relationship. An Ijara sets up a Trust which becomes the owner of the real estate property in question. The Trust then leases the property to the customer. The customer pays a portion of the purchase price every month as a rental payment. When the customer wishes to move out of the house, the Trust is obligated to sell the property to the customer under the terms of a promise to purchase; then the customer becomes the sole owner. However, while the customer is entitled to purchase the property, they are not obligated to do so.
In compliance with Sharia law forbidding unequally shared risk (Gahrar or Gharar), the Trust is the sole owner and thus takes on 100% of the loss or gain, which it then passes along to the beneficiary, who is usually the customer. This sharing of gain or loss is directly related to a Musharaka transaction. Ijara loans can be used for a wide variety of items, but are most common with high-value items such as houses. Ijaramortgages are legal under U.S. banking regulations and comply with the provisions of the Truth in Lending Act.
How It Works: The Trust purchases the property at the agreed-upon purchase price. The customer gives the down payment – which serves as an advance rent payment – to the Trust. The customer pays a percentage of the price every month as rent until they have paid off the purchase price (if they do not sell the property before then). Therefore the customer’s percentage of ownership increases each month.
Although conventional amortization schedules are used to calculate the amount of rent, the process is really a reverse mortgage. With a conventional mortgage the customer is paying off the amount owed until the mortgage is finished (the word “mort” in mortgage means “death”). With an Ijara loan, the customer is basically saving up to take over ownership; so with each payment, their share of ownership increases. When they have paid the entire amount, the customers can buy the property for $1.00. The Trust collects the insurance and property taxes as part of the rent payments.
Interest or Rent? The customer does not own the property; he or she is a renter. However, the customer has rights not granted to most renters. They can decorate, remodel, sublet, or conduct any other activity that does not have a negative impact on the property value. The customer also has all obligations for upkeep and maintenance – and can sell the property at any time.
Sharia law forbids Riba, or interest; however, the money paid through Ijara is rent. In a traditional mortgage, the customer rents the money from the bank which they use to purchase the house. Interest is the price the customer pays for the privilege of renting the money. However, with an Ijara loan, the customer is paying rent on the property (which is considered trade or “bay”), not the money; therefore, the payments to the Trust are not considered Riba.