How is the LARIBA Model different from Other Models Used by Conventional Riba Banks and Mortgage Companies?
The Conventional Riba Banker and the LARIBA Finance Institution are first concerned with:
- The ability of the borrower to repay by evaluating income and expenses of the borrower, and
- The willingness and track record of the borrower to meet their commitments as reflected by the credit reports.
Then the process differs drastically.
For the Riba Conventional, if one qualifies the Banker will need to start by defining: - The Amount of the Loan,
- The Number of Years of Repayment, and
- The Rent of the Money, called Interest Rate. The profit he makes by renting the Bank’s money to the borrower.
The Conventional Banker inputs the above data in a computer (amortization) program and solves for the Monthly Payment consisting of Repayment of Principal and the interest on the money.
In contrast, the LARIBA Model starts by asking the homebuyer to: - Define the location, address and specification of the house they intend to buy,
- Survey the rent of a similar properties in the neighborhood and come up with three independent estimates from reliable documented sources.
And the LARIBA Finance officer also gets three independent rent estimates for the same house.
This way, the buyer and the LARIBA Finance officer end up with 6 estimates of the rent. They then negotiate what they agree to as a fair rent for the property.
The following is a numerical example that clarifies the differences between the approaches used in riba (conventional) and Islamic financing:
A family wants to buy a house for $300,000. They only have $60,000 of the purchase price. They approach a bank to help them finance the house. The following is a comparison between how the process will likely go in a RIBA Banking setting as compared to Islamic Banking setting:
Riba Conventional Banker: - Evaluates the application form.
- Concludes that the family derives a good income and that they have a good balance sheet. Also, the banker finds that the family cash flow can help them pay for a larger house or even to take a bigger loan without putting the $60,000 down,
- Decides to lend the family at a certain interest rate over a period of time.
- The repayment period defined by the banker can even be longer than necessary because the banker wants to help improve the family’s surplus cash flow. In fact, it also helps the bank derive more interest income from a good qualified family as the loan repayment is extended.
- In fact, the banker may convince the family to buy a bigger and more equipped house. This is because the higher amount will represent a small addition to the monthly payment and it will be taken care of by prolonging the financing period (term of the loan).
Islamic LARIBA Banker: - Evaluates the application form.
- Concludes that the family derives a good income and that they have a good balance sheet and good tax returns. In addition, the banker finds that the family cash flow is enough to cover the monthly payment for the house purchase.
- Calls around to ask with real estate agencies such as Century 21, Caldwell Bankers the utility value of the home measured by the lease/rental rate.
- Draws an agreement with the family that complies with the Islamic Finance legal requirements. In this agreement:
4.1. The family would own 60,000/300,000 or 20% of the house (20,000 shares at $1 per share) and the LARIBA Bank/Finance Company would (temporarily) own 80% of the house (240,000 shares at $1 per share.) In the same agreement the family agrees to buy the bank’s share of the car for the same value or $(300,000-60,000=) $240,000. This way the bank does not own the asset that complies with banking rules and regulations. The family, based on their cash flow agrees to buy the shares owned by LARIBA at the $1/share price and pay back the bank’s share interest free over a period of 30 years or $80,000 per year. This is called the Return OF Capital.
4.2. The family and the Banker, independently, survey the market to find a fair leasing rate for the house. They negotiate a fair lease and agree on it. Here the lease is divided between the family (20% in the beginning and rising to 100% over 30 years) and the Bank (80% in the beginning and declining to 0% over 30 years term.) This is called the Return ON Capital for the Bank.
4.3. The family and the Islamic banker, in order to satisfy the laws of the land, sign a promissory note, which documents the repayment of the debt (no time value of money) and the declining lease rate in a total monthly payment. In order to comply with the laws of the land, the Islamic banker inputs the monthly payments representing the lease rate and the Return of Capital into a conventional amortization schedule to figure the “implied” interest rate. This rate is disclosed to the client in order to comply with the “truth-in-lending” disclosure laws.
Please note that the resulting “implied” interest rate is not uniformly the same. It differs from one home and/or geographic location to another and it differs based on the leasing rate in the relevant market.
In the LARIBA Islamic Banking environment, the Islamic LARIBA banker encourages the family to pay their home off as fast as they possibly can in order to reduce the burden of debt on the family’s cash flow and free more money to save for the future.
More here:
LARIBA- FAQ