Islamic Mortgages 45
determined profit sharing ratio. The depositors’ profit is not and should not
be determinedex-ante. On the assets side, the Islamicfinancial institution
uses various kinds of non-interest based contracts as finance instruments;
for example profit/loss sharing contract (musharaka), investment partner-
ship (mudaraba), leasing contract (ijara), cost-plus financing contract
(murabaha), andistisna’acontract (manufacturing or construction finance).
Almost all of these types of contracts have been or can be used to provide
home finance. The market and customers demand, the legal environment
and the financial institution preferences will be the main factors to decide
which of these contracts is the best to be used.
The most significant Islamic home finance instruments used are:
- Murabaha, which provides a fixed rate of return to the financial
institution; and
- Two instruments that provide the flexibility to vary the return to the
financial institution:
Ijara wa iqtina; and
Ijarawith diminishingmusharaka.
Murabaha-based home finance
The termmurabaharefers to a special type of sale where the seller has to
disclose the costs plus the profit made from the transaction. In order to use
themurabaha contract as a financing technique, the Islamic financier
incorporates the feature of credit sale (or deferred payment)in themurabaha
contract.
The modernmurabahacontract has become a very popular technique of
financing amongst the Islamic banks as it provides similar risks to
conventionalinterestbasedloan.Themurabahafinanceinstrumentoperates
in the following way:
The customer approaches an Islamic bank to get finance in order to
purchase a specific commodity. The bank purchases the commodity in cash
and sells it to the customer for the cost plus a profit. Since the customer does
not have the funds, he/she buys the commodity on a deferred payment basis.
Thus, the customer attains the commodity for which he/she wanted and the
Islamic bank makes some profit from the sale price.
The transaction will usually follow the following steps:
- The customer determines their needs (ie. identifies the house he/she
wants to purchase and agrees the initial price with the seller). The
customer then applies to the bank and promises to buy the house from
the bank if the bank agreesto provide the finance;
- The bank notifies the customer of its approval of financing the house.
The bank then purchases the house from the seller for the initial price
