Housing Financing in Islamic Law

A Study of some products for Housing Financing and applicable to Islamic Law

Dr. Salah Fahd Al-Shalhoob

Assistant Professor

Department of Islamic and Arabic Studies

King Fahd University of Petroleum and Minerals

Saudi Arabia

P.O.Box: 704

Dhahran: 31261

Saudi Arabia

E-mail: sshalhoob@hotmail.com

Phone: +966502111126

Fax: +96638602793

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 Table of content

Abstract 3

1. Introduction. 4

2. Housing financing by mark-up sales (bay‘ almurabaha). 7

3. Diminution partnership (al-musharaka al-mutanaqisa). 8

4. Commission to manufacturing (istisna‘). 10

5. Leasing ending with ownership (ijara muntahiya bi al-tamlik). 12

Bibliography. 13

Tables:

Table 1.1 Comparison of ordinary, forward and deferred sales. 5

Figures:

Figure 1.1 Ordinary sales. 5

Figure 1.2 Forward sales. 5

Figure 1.3 Deferred sales. 6

Figure 1.4 sales of a debt for debt. 6

Figure: 3.1 diminution partnership. 9

Figure: 4.1 istisna‘. 10

Figure: 4.2 al-istisna‘ wa al-istisna‘ al-muwazi. 11

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Abstract

Housing finance is considered as contracts provided by the financial institutions for the purpose of

personal finance to buy properties. There are many contracts have been discussed under the

concepts of Islamic finance, such as mark up (al-murabaha), partnership (al-musharaka), al-istisna

and leasing (al-ijara). And we can derive from the contracts some products to finance people to get

properties under the concept of Islamic law.

Murabaha is a sale contract; the seller offers a commodity to the client for the cost of the

commodity with extra sum as a profit. And the payment of the price is, normally, deferred. And

Musharaka is a sharing between at least two people, and they may share a property or investment or

so on. Ijara means lease or hire, and istisna‘ means a contract on something before it comes,

namely, an agreement between the seller and the buyer to produce a commodity and the buyer may

pay the price before or after the delivery of the product.

The above contracts are the most common contracts offered by Islamic finance, and the studies aims

to explain how these contracts can be applied for housing finance to offer contracts with accordance

to Islamic law. The study will discuss these contracts as part from the traditional Islamic

jurisprudence in brief, and then it will explain some examples which commonly practiced in some

financial institutions for the purpose of housing finance.

The study will show the concept housing finance by mark up as part of murabaha, and domination

partnership under the concept of musharaka, then hire purchase which is considered as a part of

ijara, and the last but not least al-istisna wa al-istisna al-muwazi under the concept of al-istisna.

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1. Introduction

In fact, there is no doubt that the place to live is necessary for human being, therefore it has the

priority after the need pf food and drink. Then, Islam considers the importance of housing for, so

the Qur’an indicate in the several verses that it is one of the lord blessing to his slaves; Allah says:

(‫ل‬
ِّ ‫ل ُبُيوًتا َفاْذُكُروْا َءالَء ا‬
َ ‫جَبا‬
ِ ‫ن اْل‬
َ ‫حُتو‬
ِ ‫صوًرا َوَتْن‬
ُ ‫سُهوِلَها ُق‬
ُ ‫ن ِمن‬
َ ‫خُذو‬
ِ ‫ض َتّت‬
ِ ‫لْر‬
َ ‫عاٍد َوَبّوَأُكْم ِفى ا‬
َ ‫خَلَفآَء ِمن َبْعِد‬
ُ ‫جَعَلُكْم‬
َ ‫َواْذُكُروْا ِإْذ‬

74 :‫ن( ]العراف‬
َ ‫سِدي‬
ِ ‫ض ُمْف‬
ِ ‫لْر‬
ّ ‫ل َتْعَثْوْا ِفى ا‬
َ ‫]َو‬

The interpretation of the verse is, “And remember when he made you successors after ‘Ad (people),

and gave you habitations in the land, you build for yourselves palaces in plains and carve out home

in the mountains. So remember the graces (bestowed upon you) from Allah, and do not go about

making mischief on the earth”. [Al-A‘raf: 74]

‫ والمسكن الواسع( رواه ابن حبان في صحيحه‬... ‫ ) سعادة بن آدم ثلثة‬:‫وقال صلى ال عليه وسلم‬.1

That means: (The happiness of a man in three … a broad house), reported by

Ibn Hibban.

Before we are focusing in the financial instruments which suits housing financing, we should

mention deferred sales in Islamic law, because that housing financing aims the transfer the

ownership of the houses at the end to the clients.

Deferred sales (al-bay‘ al-mu’ajjal) are a type of sale contract in Islamic jurisprudence. Sales, in

terms of the time of payment, are divided into three categories:

A- Ordinary sale (bay‘ taqlidi)

Ordinary sales (bay‘ taqlidi) are hal al-badalayn which means that both delivery of the subject

matter (al-mabi‘) and payment of the price (al-thaman) are at the time of the contract; or in other

words, there is immediate payment.2

1
See al-Mubarakfuri, Tuhfat al-ahwadhi, v. 8, p. 92.

2
See Ibn Rushd, Bidayat al-Mujtahid, 1986, v. 2, p. 125.

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B- Forward sales (bay‘ al-salam)

Forward sales (bay‘ al-salam) are when the price is immediate (hal al-thaman) and the subject

matter is deferred (mu’ajjal al-mabi‘) which means that delivery of the subject matter will come

after a specific period of time.3

C- Deferred sales (al-bay‘ al-mu’jjal)

Deferred sales are when the delivery is immediate and the price is deferred (mu'ajjal al-thaman)

which means that payment of the price is after a specific period.4

Ordinary sales Forward sale Deferred sale

Price Now Now deferred
Subject matter Now Deferred Now

Table 1.1 Comparison of ordinary, forward and deferred sales.

Payment now

Subject matter Price

Delivery now

Figure 1.1 Ordinary sales

Payment now

Subject matter Price

Delivery later

Figure 1.2 Forward sales

3
See Ibn Rushd, Bidayat al-Mujtahid, 1986, v. 2, pp. 201-202; Ibn Qudama, al-Mughni, v. 6, p. 384.
4
See Kamali, Islamic Commercial Law, pp. 131-132.

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 Payment later

Subject matter Price

Delivery now

Figure 1.3 Deferred sales

Payment later

Subject matter Price

Delivery later

Figure 1.4 sales of a debt for debt

Deferred sales, as a general concept, are lawful according to Islamic law. Not only had that, but

even the Prophet himself practiced this type of transaction.5 However, the scholars do not agree on

whether increasing the price because of deferment is permissible as well. Some of them say that it is

permissible and some others argue that it is prohibited to increase the price just because of

deferment. The majority of the jurists, including the Hanafis,6 the Malikis,7 the Shafi‛is,8 the

Hanbalis,9 and many other jurists,10 state that increasing the price due to deferment is permissible in

Islamic law, and the vendor can offer more than one price to the client whether for immediate

payment or deferred payment, as long as the negotiation on the way of payment has been discussed

before engaging in the actual contract, but when they plan to engage in the actual contract, they

have to take a decision on one of these prices and agree on the time of payment accurately.

5
Al-Bukhari, al-Jami‘ al-Sahih, v. 3, p. 1068.
6
See al-Zayla‘i, Tabyin al-Haqa’iq, v. 4, p. 78.
7
See al-Nafrawi, al-Fawakih al-Dawani, v. 2, p. 99.
8
See al-Nawawi, Sharh Muslim, v. 10, p. 158.
9
See Ibn Taymiyya, Fatawa, v. 29, p. 499.
10
See al-Mubarakfuri, Tuhfat al-Ahwadhi, v. 4, pp. 357-359; Al-Shawkani, Nayl al-Awtar, v. 5, pp. 249-250.

6
Otherwise, the contract is null and void according to Islamic law. So according to this opinion the

contracting parties have the freedom to discuss the price and the time of payment, but when they

want to engage in the contract, they have to choose only one price. This view appreciates that the

time or deferment can affect the price of the product, because, according to this view, paying the

price now is better than paying the money in the future, and traders, in general, prefer to have the

money now rather than later on, as long as the price is the same.

2. Housing financing by mark-up sales (bay‘ almurabaha)

Mark-up sales are a particular kind of sale where the seller expressly mentions the cost he has

incurred in obtaining the sold commodity, and sells it to another person by adding some money

thereon.11

Mark-up sales, as a traditional fiqh term, means that the seller declares the capital of an item, which

he has bought, to a buyer and he stipulates an additional sum as profit. 12 For example, the seller says

that the product cost him £1000 and he would like £200 extra to the capital, as profit. Consequently,

the end price of the goods is £1,200. It can be seen that the seller declares the capital and the

amount of the profit which he wants to make. This kind of sale therefore involves extra information

compared to ordinary sales in Islamic law.13

As these examples show, “bay‘ al-murabaha li al-amir bi al-shira’” which is a sale at a mutually

agreed profit margin for the orderer of the purchase, which is very common in Islamic financial

11
See Usmani, an introduction to Islamic Finance, p. 41.
12
See Ibn Rushd, Bidayat al-Mujtahid, 2003, v. 2, p. 256; Ibn Qudama, al-Mughni, v. 6, p. 266.
13
Al-Zuhayli, Financial Transactions, v. 1, p. 353.

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institutions today, was mentioned in the traditional fiqh and it has been discussed by the four

madhhabs.

Financing by mark-up sales, from a modern perspective, consists of two stages of sale and the

financial institution is involved in both contracts. Essentially, the contract is between three parties.

A (the client) orders a specific product, such as property or a car, from B (the Islamic financial

institution) then B (the Islamic financial institution) buys it for him from C (the trader or the

market). Then B (the Islamic financial institution) resells it to A (the client) on an instalment basis,

with an extra sum or profit depending on the period.14

Next, how can we practice mark-up sales. It is simply, the same procedure of the above contract,

that the client finds out a house which he wants then the financial institution starts the procedure to

buy the house by cash. Then the financial offer the house to the client by instalment payments for

the same price with margin profit depend on the period of payments. There is an important point,

that the financial institution does not sell the house before the ownership, as well as, does not

charge the client anything if he changes his mind.

3. Housing financing by diminution partnership (al-musharaka al-mutanaqisa)

Before discussing diminution partnership, we will mention in brief the definition of partnership in

Islamic law. We can divided the partnerships (al-musha>raka) in two types, the first

type is business partnership which is a contract between two or more parties

with the intention of making a business and sharing the profit. 15 The second

14
See Vogel and Hayes, Islamic Law, pp. 140-141; Usmani, an Introduction to Islamic Finance, pp. 41-42.
15
See al-Zuhayli, Financial Transactions, p. 447; Usmani, an Introduction to Islamic Finance, p. 5.

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type is the partnership of the ownership, and this type may not include the

intention business.

Diminution partnership is where a financer (financial institution) and his client participate either in

the joint ownership of a property or equipment, or in a joint commercial enterprise. The share of the

financier is further divided into a number of units and it is understood that the client will purchase

the units of share of the financier one by one periodically, thus increasing his own till all the units

of the financier are purchased by him so as to make him the sole owner of the property, or the

commercial enterprise, as the case may be.16

Bank + Client

Bank %90 Client %10

Bank %0 Client %100

Figure: 3.1 diminution partnership

4. Housing financing by commission to manufacturing (istisna‘)

16
Usmani, an Introduction to Islamic Finance, p. 30.

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The Arabic term istisna‘ lexically means requesting a san‘ah, where the latter Arabic term refers to

the work of a small or large scale manufacturing worker. Jurists use this term to refer to the request

of manufacturing a specific item in a specific form.17

Pay by delivery

manufacturer client
Deliver later

Figure: 4.1 istisna‘

Some financial institutions today make use this kind of contract to produce a new product for

housing finance, the call of the contract is al-istisna‘ wa al-istisna‘ al-muwazi. The contract means

is that the financial institution involves in the middle between the client and he contractor (al-sani‘),

so the client and the financial institution make an agreement that the financial responsible to prepare

a house to the client within a period of time, and the client may choose one of the designs, which

are offered by the financial institution, for a specific price, to be paid as an instalment payments.

Then the financial institution makes another agreement with the contractor to build the house

according to the first agreement between the client and the financial institution. So, when the

contractor build the house according to the contract, then he delivers the house to the financial

institution, then the financial institution delivers it to the client. the financial institution pay the

price to the contractor during the period of building, but the financial institution offer the house to

the client with instalment payments, and the price increases due to the increase of the period of

payment.

17
Al-Zuhayli, Financial Transactions, p. 268.

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 pays by delivery Deferred payment

contractor Bank Client

Del. when finish Del. When rec.

Figure: 4.2 al-istisna‘ wa al-istisna‘ al-muwazi

5. Housing financing by leasing ending with ownership (ijara muntahiya bi al-tamlik)

Leasing ending with ownership is of three kinds. The first kind is leasing ending with ownership by

way of gift (hiba), which means the transfer of title at the end of the lease for a token consideration

or price. The second kind is leasing ending with ownership through transfer of title at the end of the

lease for a token consideration or at a nominal price. The third kind is leasing ending with the

ownership through sale prior the end of the lease term for a price that is equivalent to the remaining

leasing (al-ijara) instalment.18

There is a discrimination upon the title of the contract, the reason is that some scholar19 consider that

the leasing ending with the ownership is against the hadith that the Prophet –peace be upon him-

“prohibits two transactions in one” because that the contract include selling and leasing in the same

agreement, and in addition this type of contract may cause a dispute between the financial

institution and the client when one of them can not fulfil the contract during the period of leasing.

So these scholars prefer to call the contract leasing with a promise to be end with ownership. It

seems today that there is no significant different between the two title, in terms of the practice of the

contract. However, there a notice different when the contracting parties dispute during the contract,

18
Rosly, Critical Issues on Islamic Banking, p. 104; see also Ahmad, Development and Problems, pp. 20-21; Usmani,
Islamic Banking, pp. 87-163.
19
Such as Ibn Muni‘, and al-Mutlaq.

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so in the first title the client may have the right to request a refund if the financial institution does

not fulfil the contract. But according to the second title the client does not have that right, because

that he is just a leaser.

Some financial institutions offer this kind of contract as an Islamic product for housing finance. So

the procedure of the contract is a client finds out a house which he wants, then the financial

institutions buy the house, and pays the price by cash. Then the financial institution offer the house

to be hired for normally a long time period, to be owned at the end of the contract and it may with a

little sum or to be owned at the end of the period of lease by way of gift.

The combination of the contract between the contract of sale and leasing may cause more disputes

between the contracting parties during the time of leasing. Because simply the financial institution

can, according to the contract, change his mind and prefers to do not sell the house to the client,

especially when the price of the houses increase while the aim of the client is to own the house at

the end of contract. So this contract needs more consideration to find out a way to be applicable to

Islamic law.

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