Fraudia: If i am not mistaken, you are talking about Morabaha Financing arrangement, which involves a sale and simultaneous repurchase agreement for the asset. I can shed some light if you want me to.
To my mind, the very essence of Islamic finance is the presence of an underlying asset on the strength of which the financing can be arranged...which essentially rules out speculative and margin instruments (sorry ChaltaHai, derivatives for sure are out! :P)
ChaltaHai: Did you manage to speak to yer Islamic Banking guys?
Although its one of the most asked topic in Islam,it remains confusing & unanswered for most of us .
I dare not sauy anything b/c neither i know banking nor am i good student of Islam However i read a discussion in related field & you can check this Pakistani Discussion forum for your self on thios topc of Interest free banking ,which you can XTRAPOLATE to your case
How Does Halal Mortgage Compare With A Conventional Mortgage?
By Thomas H. Greco, Jr.
The normal procedure to finance the purchase of a house today is to apply for a mortgage. If the price is $100,000, the bank may require a down payment equal to 10 percent of the appraised value. In case the appraised value and the purchase price are the same, the bank will require $10,000 down and lend the remaining $90,000. The buyer will sign a mortgage contract that will require monthly payments over a period of years. Typically, home mortgages run for a period of 20, 30, or sometimes as much as 40 years. The bank, of course, charges interest based on the amount of the unpaid principal, whose rate depends on prevailing market conditions and the term (time period) of the loan. Recent rates have been I n the area of 8 percent per year.
If the bank agrees to give a 30-year mortgage of $90,000, at an annual interest rate of 8 percent, the monthly payments would be $660.39. Each payment will consist partly of interest due and partly the repayment of principal. Since the interest is figured on the basis of the remaining unpaid principal balance, the interest portion will decline over time while the principal portion increases. Over the 30-year period, the buyer will make 360 such payments, which add up to a total of $237,740.40 paid to the bank. This is more than two and a half times the $90,000 borrowed, accruing $147,740.40 interest to the bank.
Now if you miss a few payments as scheduled, the bank can foreclose and sell the house to recover the amount of principal and interest you still owe. You may or may not recover any of your won investment. Since the bank’s claim has priority over yours, it will probably not try very hard to get the best price. The bank is mainly concerned about recovering its own investment, not yours, so it may set the selling price low in order to liquidate the property quickly, leaving little or nothing for you to recover.
A JUST ALTERNATIVE
But there is another way to finance large purchases like houses, or business enterprises. It is called equity sharing, or in Islamic terms, a Halal mortgage. This is nothing new. It was common practice among the Dutch banks of the 13th century, a time when laws against usury were strictly enforced. It avoids usury by avoiding debt. Let’s imagine a different kind of bank, a cooperative bank, perhaps. Instead of making a loan and asking you to sign a mortgage contract, the cooperative bank takes an equity share in your house. How would this work?
Just as in the conventional arrangement, the coop bank will require some down payment. That will be your initial equity share. Let’s assume you make the same down payment as before, 10 percent, or $10,000. The coop bank puts up the remaining $90,000. Now you and the bank are co-owners. You own 10 percent afo the house and the coop bank owns 90 percent of the house. There is no interest to be paid on the coop bank’s capital but if you occupy the house, you will be required to pay rent to the owners. Of course, since you are part owner, part of that rent comes back to you. At the outset, the bank will get 90 percent of the rental payments and you will get 10 percent. But you are also allowed to increase your ownership share at any time by making additional payments to the coop bank, in effect, buying out the bank’s interest in the house. As you do so, your proportionate share increases while the coop bank’s share decreases and the distribution of the rent payments will change accordingly.
EQUITABLE FINANCING
Let’s compare this arrangement with the conventional mortgage in the example given above. The big question, of course, is, what is a fair amount for the monthly rent? It might be reasonable to assume that it is equal to the monthly payments you would have made under the conventional mortgage arrangement, in this case, $660.39. At the outset, you will receive ten percent of that rent as your ownership share and the co-op bank will receive 90 percent, Let us also assume that you apply your share of the rental payments to increasing your share of the ownership. Table A is an abridged amortization table which shows the respective returns to you and the coop bank.
Under this arrangement, you will own 100 percent of the house after making the 350th payment, or in 35 and 2/3 years. You will have paid total rent of $231,018.30. The bank’s total share will have been $141,018.30. This is a saving of more than six thousand dollars over the amount of interest paid on the conventional mortgage. In percentage terms, this is a saving of little over four and one half percent. This may not seem like much, but, as we shall see when we compare this approach with conventional mortgages carrying higher interst rats, the savings can be enormous.
A more important advantage derives from the risk sharing inherent in the shared equity approach. Under this arrangement, if you are unable to make the additional principal payments, there is no foreclosure, you simply do not add to your ownership share. If you are unable to pay the rent, however, you could be required to vacate the house, just as if you were renting from anybody else, but you would not lose your ownership equity. When the house is rented to someone else, you would still receive your share of the rent, or if the house were to be sold, you would get your share of the proceeds based on the percentage of the equity that you own. Of course since the coop bank’s claim does not take priority over yours, it is in the best interests of both you and the bank to try to get the highest price possible for the house.
Compared to the conventional mortgage debt, the relationship between you and the coop bank is amicable rather than antagonistic, where interests are congruent rather than opposed. The conventional mortgage being exploitative creates conflict, stress, and insecurity, and makes for a more harmonious and equitable society.
THE NUMBERS MATTER
To fully appreciate the advantages of the shared equity approach, we need to examine the numbers pertaining to higher conventional mortgage interests rates. Table B shows the figures for conventional mortgages at 8, 10 and 12 percent interest, along with figures for comparable halal mortgages. It can be seen how seemingly small changes in the interest rate cause enormous increases in the amount of money you must pay back. At 12 percent interest, for example, you will repay $333,270.00 on your$90,000 loan over 30 years, giving the bank interest income of $243,270.00. However, a shared equity or halal mortgage with the same monthly payment of $925.75 would give you full ownership in 20 and 5/6 years. The total rent shares to the coop bank would be only $141,323.14, saving you over $100,000.
The figures in this table assume that the fair rent in each case is equal to the mortgage payment. That assumption, however, may be too far fetched. Let’s assume that, in every case, the fair rent is equal to the mortgage payment at 8 percent, or $660.39. Under these circumstances, any amount paid over and above that figure would be directly applied to increasing your equity share rather than being split between you and the coop bank. The lower part of the Summary Table shows the figures for monthly payments equivalent to those at the 10 and 12 percent mortgage rates. With payments of $789.81, you will achieve complete ownership in only 13 and 1/12 years, having paid the bank rent shares of only $54,481.83, saving you almost $189,000 or 77.6 percent over the conventional mortgage with the same montly payment.
Thomas H. Greco, Jr., a community economist, writer, networker, and consultant, who for the past 20 years, has been working at the leading edge of transformational restructuring. A former college professor, he is currently Director of the non-profit Community Information Resource Center (CIRC), Tucson, Arizona, a networking hub and information source, which provides support for efforts in community improvement, social justice, and sustainability.
His articles have appeared in many journals, and he has authored and published tow books: New Money for Healthy Communities and Money and Debt: A Solution to the Global Crisis. He is a past President/Trustee of the School of Living, and organized the Fourth World Assembly and New Economics Symposium in San Francisco in 1987. Web site http://azstartnet.com/~circ/
