Shariah-Compliant Home Finance Defined
The Holy Quran (3:130) states, “O you who believe! Do not devour usury, making it double and redouble, and be careful of (your duty to) Allah, that you may be successful.”
Shariah-compliant Islamic finance is any investment fund that meets and honors all the demands, requirements and principles of Shariah, or Islamic law. The principles of Shariah prohibit certain types of income, such as riba (commonly referred to as interest). As such, Shariah-compliant financial instruments are prohibited from charging interest or paying interest.
Rules for Shariah-Compliant Funds
The rules of using Shariah-compliant funds include the following:
- Investment of the funds in Shariah-compliant companies
- Shariah board approval and certification
- Annual Shariah-compliant audit to monitor and validate authenticity and transparency
Why Shariah Compliance?
For a practicing Muslim, a Shariah-compliant finance product provides great confidence because it is reviewed and approved by a Shariah board comprised of eminently learned scholars from across the world who take due diligence in supervising and certifying financial products. Additionally, Shariah law places great importance on ethical and equitable financing, social welfare and economic development.
Shariah Compliance Around the World
Islamic banks, especially in Muslim-majority countries, offer a range of investments that follow Islamic principles. Other international banks such as HSBC, Crédit Agricole and Standard Chartered have established Shariah-compliant banking divisions and advised corporations and governments on issuing “Sukuk” (Islamic equivalent of a bond) and other financial products. Companies in the United States are considering Islamic finance to fund business ventures and infrastructure projects. This shows the gradual acceptance of a Shariah-compliant financing model across the world.
Sharia Compliant Mortgages
An Islamic mortgage isn’t actually a mortgage loan — it’s based on a different foundation.
Like other Shariah-compliant investments, mortgages must follow Islamic finance principles, which prohibit riba as well as other problematic practices such as gharar (speculation or contractual uncertainty), and maysir (gambling).
These ethical principles are practical as well, helping to protect individuals as well as broader communities. This means traditional mortgages are not an acceptable option, especially when halal alternatives exist.
Types of Islamic Mortgages
The three most common types of Islamic mortgage contracts in the West are Murabaha, Ijara, and Musharakah.
Murabaha
In a Murabaha contract, the financier buys the property and sells it to the buyer at a previously agreed-upon profit. The buyer repays the financier in installments over a specific period. A downside is that Murabaha creates an obligation for the home buyer that can resemble debt.
Ijara or lease-to-own financing
In the Ijara model, the financier purchases the property and then leases it to the buyer, who makes monthly payments that include both a portion of the property price and a rent payment. At the end of the lease period, the buyer owns the property outright. A downside is that the home buyer does not enjoy homeownership rights until repayment is complete.
Musharaka: The Preferred Choice
In a Musharaka contract, the home buyer and the financier invest in a property and purchase the home together, and the home buyer gradually buys the financier’s stake in the property, paying an additional fee for full usage rights to the property.
Musharakah is considered the preferred option in the United States. The buyer maintains full ownership rights for the property from the start, like any other homeowner, plus additional benefits and protections not found with a traditional mortgage such as risk sharing.
Guidance Residential and Shariah compliance
Guidance Residential is the largest provider of Shariah-compliant Islamic home financing in the U.S. Our home financing program called the Declining Balance Co-Ownership Program is modeled from the Islamic concept of Diminishing Musharakah.
In this ethical alternative to a traditional mortgage, Guidance and the homebuyer engage in a joint ownership venture. When a homebuyer makes monthly payments to Guidance, they are buying Guidance’s shares of the ownership so that they will eventually gain full ownership of the home. As the sole inhabitant of the property, the home buyer pays Guidance a profit fee for utilizing Guidance’s share in the property.
An independent Shariah board has certified the product and performs an annual audit to establish Shariah compliance.
Shariah-compliant home financing honors the principles of Shariah, while benefiting from the best of what is available in the modern financial marketplace.
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Originally published in October 2017, updated January 2024.
