48 Islamic Finance in Practice
The customer will make two monthly payments; the first is for the rent
charged by the bank for allowing the customer to use the bank’s share in the
house. The rent rate is normally bench marked to LIBOR, or similar indices.
The second payment is for the acquisition of a portion of the bank’s share.
The bank will sell its share usually at the same purchase price of the
property and any depreciation or appreciation of the house value will be
passed to the customer.
Themusharakaandijarabased home finance transaction will usually
follow the following steps:- The customer identifies the house and agrees the price with the seller.
The customer then will apply to the Islamic bank to finance the house;
and - The bank notifies the customer of its approval. Then both the bank and
the customer buy the house and become partners. At this stage, both
parties will first sign the diminishingmusharakacontract where the
bank agree to sell its share to the customer over the term of the contract,
and then will sign theijaracontract where the bank leases its share to
the customer.
The bank will usually keep legal title of the house for the duration of the
contract, and the diminishingmusharakacontract will record the customer’s
share (or the customer’s beneficial interest). The bank and the customer will
share the costs,pro rata, of all major costs including the provision of the
house insurance, but all the expense related to the ongoing use of the house
should be paid by the customer. Both partners will also share the risks
associated with the house ownership in accordance with each partner’s
share. If the house is destroyed during the lease period, both parties, as
partners, should suffer the loss. If the leased house loses its usufruct without
any misuse or negligence from the customer side, then the bank will not be
entitled to receive any rent until thehouse is restored to usable form.
Ijarais a lease contract; this means that the rent can be reviewed
periodically. The review period is usually set at quarterly or semiannual
basis but can be as long as a few years or as short as a month. This makes
ijaramore flexible thanmurabahaas it provides a variable rate of return,
which can be locked as long as required.