Islamic Mortgages 47
Ijara-based home finance
The termijararefers to a leasing contract. Theijaracontract has not been
used traditionally for finance purposes; rather it was used for normal leasing
activities. However, Islamic banks have found that leasing is one of the
main recognized types of finance throughout the world and it is a lawful
transaction according to Shari’a, therefore it makes perfect sense to develop
new financial instruments based onijara, including home finance instru-
ments. The home financeijara-based instrument are usually called “ijara
wa iqtina” (lease and purchase), which is in a way similar to financial lease
and hire purchase.
Under this agreement, the Islamic bank purchases the house selected by
the customer, and the customer enters into two contracts with the bank−a
leasing contract and a promise to sell. The first contract is a leasing contract
where the customer agrees to pay periodic rent to the bank during his
occupancy of the house until the end of theijaracontract term, and the
second contract is a promise to sell , where the bank undertakes to sell the
house to the customer, usually for a nominal price at the end ofijara
contract.
The rent paid by the customer can be usually reviewed on a quarterly or
semi-annual basis allowing the rent rate to be changed based on an agreed
benchmark, usually London Interbank Offered Rate (LIBOR) or similar
indices. The customer pays the bank monthly instalments; each instalment
is a combination of a variable rent payment under the leasing contract,
together with a fixed payment to pay for the house price which usually will
be divided over the term of the contract.
Theijara wa iqtinamethod for home finance has decreased in popularity
due to the fact that technically, the customer is paying rent, although part
of this rent is to cover the purchase of the property; this part of the rent
payment does not create any ownership right as the ownership will only be
transferred at the end of the contract when the customer will exercise the
promise to sell.
Diminishing musharaka and ijara-based home
finance
Home financing based on diminishingmusharakaandijarais unique to
Islamic finance. It is based on the idea of shared equity rental. Under this
housing finance instrument, the customer and the bank jointly acquire and
own the house. The bank then leases its share of the house to the customer
on the basis ofijara. The bank will allow the customer togradually purchase
the bank’s share so that the share of the bank reduces and the customer
share increases gradually over time, until the end of the contract term,
where the customer will becomethe sole owner of the house.
