Shari’ah compliant mortgage financing in America

Shari’ah compliant mortgage financing has been available in the United States for over a decade.  Research into how these mortgages are structured reveals the details behind this Islamic finance program and how it differs from the standard FNMA mortgage loan documents.

The loan documents used in a Shari’ah compliant mortgage transaction are identical to a conforming conventional (FNMA) loan package, with the addition and amendment of a few disclosures in the closing package that assure the borrower (the Consumer) that the financing he has obtained is a valid Diminishing Musharakah and is Shari’ah compliant.  In a Diminishing Musharakah, a financier (Co-owner) participates with the client (Consumer) in the joint ownership of a property or equipment.  For instance, a homebuyer has twenty percent to put down on the home purchase and he forms an arrangement with the financier (Co-Owner) which lends the remaining eighty percent.  As the Consumer makes payments his ownership percentage increases.

One of the disclosures present in the loan package is entitled “Declining Balance Co-Ownership Home Acquisition Program Fatwa on Disclosure” and reads as follows:

“We, the Shari’ah Supervisory Board of Guidance Financial Group, LLC understand that state and federal government agencies, including the Federal Reserve Board and the Internal Revenue Service, require home finance companies to provide to consumers various disclosures and representations. Such disclosures refer to the terms “loan” and “interest,” require the calculation of an annual percentage rate to allow the comparison of one financier to another, and have not been approved by the government for modification to reflect Islamic transactions in which interest is not present.

Such disclosures do not constitute the Islamic contract to which the Consumer is committing. (Writer’s italics) Therefore, the Shari’ah Supervisory Board does not object to the Company providing such disclosures to the Consumer. The Board further does not find that such disclosures, with their references to “interest” for the reporting of tax and other disclosure purposes only, corrupt or invalidate the Shari’ah documents to which the Consumer is committing.

The Board encourages Guidance Financial Group to work with various state and federal agencies to modify the documents in such a way as to reflect the interest-free transaction offered by the Company.” (Writer’s italics)  This document is dated and signed on a date prior to the closing date of the transaction and is signed by the members of the Board.

On the truth in lending disclosure, amortization schedule (named the Schedule to Co-ownership Agreement), Note (named Obligation to Pay), and payment letter, the mortgage payments, which normally consist of principal and interest, have been revised and are divided into an Acquisition Payment and a Profit Payment.  The Acquisition Payments, or principal reduction as we understand it, “represent the Consumer’s payments for his acquiring the Co-Owner’s interest in the property.”  The Profit Payments, which is the interest portion, “represent the Consumer payments for the enjoyment and use of the whole property.”

There is an additional fee charged to the Consumer, an ongoing LLC fee, which provides compensation to the lender for their maintenance of the Co-Owner structure and is disclosed in the monthly payment letter.  This is included in the calculation of the annual percentage rate (APR) as required by federal law.  One LLC can serve as Co-owner of up to twenty-five separate properties with twenty-five separate Consumers.  The Co-owner assigns his interest in the Security Instrument, or Mortgage, to the Lender, or Mortgagee.

To summarize, a Shari’ah compliant mortgage transaction substitutes the terms Co-owner for the Lender, the Consumer for the Borrower, Acquisition Payment for Principal Payment and Profit Payment for Interest Payment, which, by the way, can be fixed or adjustable.  This cannot be called “interest” as charging interest between Muslims is not permissible under the shari’ah.

Does this pass the scrutiny of the federal Fair Housing Act  and HUD’s Office of Fair Housing and Equal Opportunity?  Is a non-Muslim permitted to acquire property under the terms of this program?  How is this program permitted with a disclosure included which states: “Such disclosures do not constitute the Islamic contract to which the Consumer is committing.”  This is saying that they know they are signing documents only to satisfy the laws of the United States of America and are not valid under shari’ah.

I would hate to know what happens in the event of a default.