Is taking out a mortgage halal or haram?
This is one of the most essential questions facing Muslims in the modern world. For many Australians, taking out a mortgage is not something that they think about from a moral perspective.
But Islam provides clear guidance on a range of financial contracts and practices. As Muslims, it is important to analyse what we are doing with our financial decisions and to make sure that we are not compromising our values through them.
There are arguments both that traditional mortgages are halal or haram. But to complicate the issue, there is also the added consideration of the Islamic mortgage option.
In this article, we will provide a non-biased opinion about how a traditional mortgage can be considered halal or haram, and we will also explain how Islamic home finance works as an alternative. So, let’s jump straight into it!
Why Would a Traditional Mortgage Be Haram?
The fundamental reason why a traditional mortgage is considered to be haram by many Muslim scholars and leaders is that involves interest. This is also referred to as usury, and the related Islamic concept is riba.
However, there are also two further important concepts that relate to the financial mechanics of mortgages. These are the concepts of gharar and maysir.
Before we go into these concepts in detail, we should consider exactly how mortgage interest works.
How Does Mortgage Interest Work?
When we take out a mortgage—which is often called a home loan—we are borrowing money. We approach a bank or other lender and ask them to loan us the money to buy a specific house. We agree to repay that money back over a certain period of time.
But the crucial thing (and the reason why lenders give us the money in the first place) is that we are obliged to pay interest on the amount we have borrowed. This interest can end up being a very large amount of money.
The amount of interest you will pay on a mortgage depends on the size of your loan, how quickly you pay it back, and what the agreed interest rate is. The average size of a mortgage last year hit $500,000. SO, the interest you can expect to pay on this is going to be very large.
The average mortgage in Australia lasts for between 10 and 30 years, so you can expect to rack up the interest of tens of thousands of dollars, or even a lot more.
It is precisely this type of lending scheme that has made many Muslims believe that traditional mortgages are haram. But why is this the case? It all comes down to riba.
What Is Riba?
Islam is unique amongst world religions in that it provides detailed guidance on many matters that are not inherently spiritual. One of the main examples of this is that it guides believers on how to conduct financial relationships. At the very core of this guidance is the concept of riba.
Riba translates into English as either interest or usury. It refers to the concept of lending a particular amount of money and expecting a larger amount in return.
The Quran takes a very clear stance on this practice. It says: ‘O believers, devour not usury (riba), doubled and redoubled, and fear you God; haply so you will prosper’ (3:129-130).
There are also some other verses that refer to the concept, which provide greater clarity on why it is prohibited. In particular, the Quranic verse 2:275-280 is indicative.
There are two main reasons why riba is prohibited. The first of these is that the money one earns from committing usury requires no effort. God wishes each person to work hard and prosper from their labour.
The other aspect is that riba is more or less the antithesis of the charity, love, and compassion that the Quran calls believers to live up to. For, if someone is in need of money, the charity would dictate that the community supports that person and does not benefit unjustly from them.
What Is Gharar?
Gharar translates into English as something like risk or uncertainty, and it sometimes also has the connotation of deception.
The reason that a mortgage may fall under the concept of gharar is that many mortgages involve variable interest rates. A variable interest rate is the opposite of a fixed interest rate.
In a variable interest mortgage, the lender and the borrower agree to an initial interest rate that may then change over time. There are numerous factors that will cause interest rates to change.
In any event, Islamic law is quite clear that Muslims should not engage in financial practices that involve gharar. The primary reason for this is that God wishes his people to engage in open and honest business relationships.
If interest rates change during a mortgage, then of course there is significant risk and uncertainty in the contract.
What Is Maysir?
Maysir is generally translated into English as gambling. However, it is not limited to describing games of chance like poker or slot machines. More broadly, it refers to financial activities in which chance is involved.
The reason that Islam prohibits Maysir is more or less the same as why it prohibits riba. That is, maysir implies the possibility that someone will profit not from productive labour but from the possession of their money alone.
Once again, this is relevant to the situation of a mortgage with a variable interest rate. In this circumstance, one party may unduly benefit from the other without having done anything to deserve it.
Arguably, however, the concepts of gharar and maysir do not need to be applied to the question of mortgages because they relate to the question of interest (or riba), which is already haram.
Is a Traditional Mortgage Haram?
A traditional mortgage does seem to be quite a clear case of someone benefitting from riba, in which case it would be haram.
However, on the other hand, there are some strong arguments for why a traditional mortgage might still be halal. In the first place, taking out a mortgage is quite a different thing from lending money to others and earning interest from them. Arguably, the buyer of the mortgage (assuming they do not use a variable interest rate) stands to gain no direct financial benefit from their contract with the lender.
Another possible interpretation is that a mortgage constitutes what is called murabaha. This is an Islamic financial concept relating to the purchase of goods using the services of someone else. The price of the service is a markup on the goods that are bought.
Critics argue that a traditional mortgage does not constitute murabaha because it still involves interest. However, the murabaha agreement is one of the possible principles of an Islamic mortgage (below).
We will let you decide your own conclusions.
What Is an Islamic Mortgage?
An Islamic mortgage is different from a traditional lender-borrower scenario in one of three possible ways. The first of these we have already mentioned: Murabaha.
In a Murabaha mortgage, the bank would actually be the one to buy the house on your behalf. They would then charge you a markup for the property, which you could pay in a set of instalments over a certain period of time.
Even though it is often referred to as a mortgage, the Murabaha agreement is often criticised as being haram because of its similarity to a traditional mortgage.
The second possible type of Islamic mortgage is called an ijara. The concept of the ijara means that an individual will rent a property at an agreed rate over a fixed term and, at the end of that term, will take ownership of it.
This is obviously similar to the Murabaha agreement. However, the key difference is that the ‘lender’ (who is not really a lender in this scenario) is the one that owns the property.
Once again, this concept has also faced criticism for its essential similarity to a traditional mortgage.
The final Islamic mortgage option is the musharaka contract. In this situation, you enter into a partnership with the ‘lender’ to buy a house. Over time, you then pay the ‘lender’ until you eventually gain full equity.
There is some difficulty in this situation because the value of the property will continue to change. This would then bring in the concepts of gharar and maysir mentioned above.
As with a traditional mortgage, we will let you make up your own mind about whether an Islamic mortgage is halal or haram.
Be Considerate in Your Dealings
Whether you opt for a traditional mortgage, an Islamic mortgage, or neither, it is important that you always consider the moral implications of your financial decisions. One of the main reasons for this is that it will allow you to feel happy that you have not compromised your values.
This can be a difficult thing to achieve in the modern world, where we are continually tested by things like mortgages and other financial decisions.
If you would like to talk about how you can make morally considerate financial decisions, why not get in touch with us today?
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Ethical Finance and Innovation
Dr. Sayd Farook is the Executive Director of Crescent Foundation. He is Group Chief Operating Officer of Crescent Wealth and Managing Director of Crescent Finance. He previously served as Advisor to the Executive Office of the Vice President and Prime Minister of the UAE and Ruler of Dubai. In this capacity, he envisioned and executed strategic / transformation initiatives for Dubai and the UAE. Prior to that, he was the Global Head Islamic Capital Markets at Thomson Reuters, where he advised and served large corporates, multilaterals and governments in the Middle East, North Africa and South East Asia.