Shariah Residential Property Finance Explained
Shariah finance principles are derived from Islamic law and encourage ‘fair play’ that promotes an ethical way of conducting financial affairs. It is suitable for Muslims and non-Muslims alike.
The Shariah finance principles seek to promote trading and enterprise to generate real wealth for the benefit of the community as a whole. It does this in a way that provides stability, is transparent and provides for the sharing of both risk and reward in an equitable way.
The key differences of Shariah finance compared to conventional finance are as follows:
- Any investments and finance must not be used to support prohibited activities which are against the principles of Shariah (including any connection with tobacco, alcohol, gambling, the sale of arms and adult entertainment).
- Money must be put to a good use to generate profit supported by genuine trade or a business related activity. As such the giving or receiving of interest (making ‘money from money’) is prohibited. Therefore the way property is financed differs compared to conventional finance – how this works in practice is outlined below.
How our residential property finance works in practice
Rather than the payment of ‘interest’ on the finance provided by a Bank to purchase a property, the Bank and customer jointly buy the property with each having a beneficial interest according to the amount each has contributed. The customer leases the part of the property owned by the bank and pays a monthly ‘rental payment.’ The Bank is the registered owner for itself and the customer. At the end of the finance term, if all payments have been made, ownership of the property transfers to the customer.
In Shariah finance the process of buying an increasing share in the ownership of the property every month is called ‘Diminishing Musharakah’. Musharakah means ‘joint venture’ and is an Arabic term used to describe this form of property finance agreement.
Similar to the conventional way of buying a property there are two forms of a Diminishing Musharakah agreement – Acquisition and Rent Only, which are explained below:
Acquisition Diminishing Musharakah
Both the customer and the Bank each contribute a percentage towards the purchase or refinance of a residential property. The Bank will then lease its share in the property to the customer for the duration of the finance term.Over the finance term, the customer will make monthly acquisition instalments through which the Bank will sell its share of the property to the customer. With each acquisition instalment, the Bank’s share in the property diminishes while the customer’s share increases.
While the acquisition instalments are being made, the Bank will charge the customer rent for the use of its share of the property, which is calculated according to the respective shares owned.
Following the customer’s acquisition of the Bank’s entire share, either at the end of the agreed term or upon early purchase of the Bank’s share, whichever is earlier, the Bank will transfer registered ownership of the property to the customer.
Rent Only Diminishing Musharakah
Both the customer and the Bank will each contribute a percentage towards the purchase or refinance of a residential property. The Bank will then lease its share in the property to the customer for the duration of the finance term.
Over the finance term, the customer will make monthly payments to the Bank which will comprise of rent only. This means that during the term of the finance, the customer is not acquiring any shares of the property from the Bank and as a consequence the customer’s share in the property during the term will remain the same.
To acquire the Bank’s share in the property, the customer will either need to pay part lump sum instalments prior to each rent review and/or make a full lump sum instalment at any time or at the end of the agreed term.
Until the Bank’s share had been acquired by the customer, the Bank will charge the customer rent for the use of its share of the property. The rent is calculated according to the respective shares owned.
Following the customer’s acquisition of the Bank’s entire share, either at the end of the agreed term or upon early purchase of the Bank’s share of the property, whichever is earlier, the Bank will transfer registered ownership of the property to the customer.
It is the customer’s responsibility to make sure that they put in place, maintain and regularly monitor, any financial arrangement that is expected to provide a lump sum sufficient to acquire the Bank’s share at the end of the agreed finance term.