Islamic Finance

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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. This Islamic finance process is very simple. A single asset Trust is created whereby the Trust purchases the property, and then leases the property to the customer. A portion of each monthly payment goes towards ownership, until the customer owns 100%.

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

How The Purchase Price Of The IJARA Transaction Determined

The purchase price 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, the initial amount the customer has to pay the investor for 100% ownership is $160,001. As the customer makes more payments, this amount reduces, until the final ownership payment of $1.00 is reached.

How The Monthly IJARA Rent Payments Calculated

The initial Ijara Islamic finance amount 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 these 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 acceptable to describe the profit on an Islamic finance transaction as a percentage. The following example highlights the acceptability of quoting the profit as a percentage in an Ijara transaction:

  1. Suppose you have a $100,000 in cash.
  2. You purchase a home and pay cash for the home.
  3. You rent the home to a tenant for $250 per month
  4. At the end of the year you have collected $250 x 12 or $3,000 in rent
  5. That $3,000 in rent is a 3% return on your $100,000 investment
  6. This 3% is rent on property which is Trade (Bey)

Is that 6% Rent or Riba? well it is clearly it is Rent since it is based upon a business transaction. Now let’s look at a traditional mortgage interest transaction:

  1. Starting with the same $100,000 cash.
  2. You give someone the money.
  3. They proceed to purchase the same home with those funds.
  4. They pay you the same $250 per month, or 3% a year for use of the money.
  5. This is basically rent on money or Riba

In this case is the 3% Riba? Yes, as it is rent on money. The first example was rent on property. From a Sharia perspective it is acceptable to describe the profit on an Islamic Ijara transaction as a percentage. It’s also a requirement under the Truth in Lending Act/Consumer Protection Act; any profit earned on a residential real estate finance transaction should be described as a percentage so a customer can clearly understand what the overall cost of the financial transaction is.

Tenant Or Homeowner?

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

Sharing Of a Gain Or Loss

One of the basic Sharia compliance principles is there should be a sharing of either a gain or loss in any Islamic finance transaction. The Ijara transaction is structured in such a way 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:

  1. The Trust will transfer the title of the property to the customer,
  2. The customer will then transfer the title to the new buyer,
  3. The new buyer will then settle the transaction according to the agreement with the customer,
  4. And then the customer will settle with the trust according to the agreement between the customer and the trust (the Ijara documents)

These procedural steps create a situation where the customer holds 100% title, albeit for a short period of time, and is 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. Find out more about Ijara Contracts or Forward Dated Ijara Contracts. There are links to Other Islamic Finance Topics

  1. Aqd
  2. Bayu-al-amanah
  3. Bai-Al-Inah
  4. Bay al-kali bil kali
  5. Bai’ bithaman ajil
  6. Bai’ muajjal
  7. Bay Al-Mudaf
  8. Bai al Dayn , Bai Salam
  9. Gharar subtopic: Different Types of Gharar
  10. Halal Mortgage
  11. Hawala
  12. History of Islamic Banking
  13. History of Islamic Finance
  14. Ijara Loans
  15. Ijarah Financing
  16. Ijara Calculator
  17. Ijara Canada
  18. Islamic Banking
  19. Islamic Calculator
  20. Islamic Finance Canada
  21. Islamic Investment
  22. Islamic Mortgage USA
  23. Istisna
  24. La Riba
  25. Mudarabah
  26. Musawamah
  27. Suftajah
  28. Tawliyah
  29. What is a Trust
  30. What are Sharia Compliant Mortgages
  31. Qard Hassan
  32. Sukuk Al-Ijara
  33. Benefits of Ijara for Lessee
  34. Conditions for Ijara Contract to be Valid
  35. Comparison between Ijara and conventional operating lease
  36. How Ijara Financing Works
  37. Ijara and Renting
  38. Ijara Financing : Its Salient Features
  39. Ijara as a Financial Lease
  40. Ijara – Benefits to Financial Institutions
  41. Ijara – Benefits to Airline Industry
  42. Ijara – Benefits to Agricultural Industry
  43. Ijara – Benefits to Multinational Organizations
  44. Ijara – Benefits to Industrial Sector
  45. Ijara – Benefits to Businesses
  46. Ijara – Benefits to Real Estate Sector
  47. Ijara – Beneftis to Individuals
  48. Ijara as an Operating Lease
  49. Ijarah Muntahia-bi-tamleek
  50. Ijara Thumma al bai
  51. Ijara wa Iqtina
  52. Ijarah with Diminishing Musharakah
  53. Practical Applications of Ijara