Education – Does Interest-Free Home Financing Facility Exist?

Singapore (13 August 2020) – It’s ethical. It’s interest-free. In some cases, you could slash the tenure of your mortgage by half. These are just some of the features of an interest-free Shariah-based home financing.

Sounds amazing? Yes. Is facility available in Singapore? Uhmm…no, well at least not yet. Impossible to have? No. Open to people of all faiths? Certainly.

Interest-free home financing has been mentioned since the early seventies elsewhere in the world.

As Muslims are not allowed to pay and consume interest, it is incumbent upon them to be aware of the availability of such financing structures and understand how these financing models work, even though such facilities aren’t yet available in Singapore. Perhaps they could avail themselves to such facilities when investing in overseas properties.

This article is the first of a three-part Halal Universe series on interest-free home financing. We are kicking off the series with this first article highlighting the three basic financing structures that Islamic banks and financiers outside of Singapore are using when designing their financing facilities. The second part of the series will feature actual financing models and their variations in countries including Australia, the US and Canada. The third part of the series will look into the practicality of having a Shariah-based home financing in Singapore.

The 3 Basic Financing Models 

There are at least three basic financing models:

1. Musharakah Mutanaqisah or Diminishing Partnership
2. Commodity Murabaha
3. Ijarah Muntahiyah Bitamlik or Leasing-to-Purchase

 

Model 1: Musharakah Mutanaqisah

This concept was first propounded in the early seventies. The term musharakah means sharing, participating or participation, while the term mutanaqisah derived from the root word naqasa means decreased, diminished, lessened.

The term musharakah mutanaqisah (MM) means “diminishing partnership” whereby one partner’s share will be decreased or diminished. It is a partnership contract between two parties in a project with income, whereby one party commits to gradually buying over the share of the other. (1)

According to Shariah scholar Taqi Usmani, it is a concept whereby a financier and a buyer jointly participate in the ownership of a property or equipment whereby the buyer will purchase the share of the financier until he becomes the sole owner of the asset. (2)

Musharakah Mutanaqisah has three contractual elements – musharakah (partnership), ijarah (lease) and bay (sale). In addition there is also an element of wa’ad (promise) whereby one party promises to rent that which he doesn’t own and buys the shares of his partner. (3)

How MM works

• Financier and buyer (client) create a joint ownership in the property
• Financier rents out that part of property he owns to client
• Client promises to buy that part of property he doesn’t own from financier in units
• Client makes actual purchase of units at different stages
• Rental payments are adjusted in accordance to financier’s remaining share of property (4)

For example a buyer enters into a partnership agreement to buy a property with his financier on an agreed 10:90 share financing arrangement. The buyer will make monthly payments to the financier. The payments will consist of 2 components – one component is rental for that part of the property that he doesn’t own and the other component is payment to gradually buy over units of the property owned by the financier. As buyer’s share of the equity in the property increases, and his partner or financier’s diminishes over time, his rental payments too could be expected to reduce over time. He stops making rental payments once he owns the property 100%.

In Malaysia, the Musyarakah Mutanaqisah financing structure is popular amongst the community. The number of Islamic banks offering such home financing contracts, however, has fallen over the years. In 2017, there were only 5 banks in Malaysia offering MM compared to 8 banks in 2018, according to Zaaba and Hassan, quoting Mat Ali and Subky et al. (5)

 

Model 2: Commodity Murabaha (Tawarruq)

The term Murabaha means “Cost-Plus” Financing.

Commodity Murabaha also known as Tawarruq means “Cost-Plus Deferred Sale of Commodities” is a popular financing structure amongst Islamic banks. It is, however, riddled with controversy. There have been recent pronouncements by some scholars that the Tawarruq arrangement is not permissible. The main argument against Tawarruq arrangement is that the structure is arranged and therefore not a genuine transaction. (6)

How it works:

• A property buyer purchases a property from a developer or vendor by signing a Sale and Purchase Agreement.
• He then approaches an Islamic Bank for financing of the purchase of property.
• The Islamic Bank sells him commodity – palm oil, cocoa and the like – at cost-plus-bank’s profit (x+y); x being principal and y being total profit accruing to the bank on deferred payment term.
• Since the property buyer has no use of the commodity, he appoints the Bank to sell the commodity on his behalf
• The Bank sells the commodity in the market on a spot/cash basis at cost (x).
• The Bank then credits the sale proceeds (wariq) to the developer or via the customer subject to agreement of both parties.
• The property buyer repays the bank principal + bank’s profit (x+y) by way of agreed payment schedule for e.g. over a tenure of 40 years
• The property is charged to the Bank as collateral. (7)

Model 3: Ijarah Muntahiyah Bitamlik (Lease-to-Purchase)

One of the meanings of Ijarah has to do with the usufructs of assets and properties. According to Shariah scholar, Taqi Usmani, Ijarah means “to transfer the usufruct of a particular property to another person in exchange for a rent claimed from him.” (8)

Like commodity murabaha, leasing is a business transaction and not a mode of financing. However, Islamic banks have overtime applied Ijarah as one method to offer financing to customers.

Some Islamic banks in Malaysia offer Ijarah Muntahiyah Bitamlik or Leasing-to-Purchase contract as a form of property financing to clients.

How it works:

1. The customer purchases an asset from a seller by paying down payment.
2. The customer then approaches an Islamic Bank for Ijarah financing. Upon approval, the Bank purchases the asset from the customer.
3. The Bank pays the remaining purchase price of the asset to the vendor pursuant to the purchase from the customer.
4. The Bank leases the asset to the customer by executing an Ijarah Muntahiyah Bitamlik agreement and the customer pays the lease throughout the lease period.
5. The Bank will sell the asset to the customer at nominal value upon maturity. (9)

In our next article, we will look into how these financing structures have been applied in some countries and the community’s reception of such financing structures. -/- www.halaluniverse.net

References:

1. Azman Ismail, A Dynamic Financial Analysis On The Extended Mathematical Model of Musharakah Mutanakisah for Consumptive Financing, 2^nd International Conference on Mathematical Sciences
2. Ibid. p4
3. Ibid. p5
4. Ibid. p7
5. Zaaba, Hassan, Why Islamic Banks Are Reluctant to Offer Musharakah Muntanaqisah for Home Financing: The Case of Malaysian Islamic Banks, pg 55
6. Amir Alfatakh, Financing: Tawarruq (Commodity Murabaha), Islamic Bankers Resource Centre, https://Islamic.bankers.me
7. Bank Islam, Application of Shariah Contracts In Islamic Banking Products & Services
8. Maulana Taqi Usmani, Islamic Finance – Musharakah & Mudarabah , http://www.darululoomkhi.edu.pk/fiqh/islamicfinance/ijarah.html
9. Bank Islam, Application of Shariah Contracts In Islamic Banking Products & Services