House ownership

[gilynn]

I would love for someone to fact check this as I am not an expert

Suppose you have a 100K house that you’d like to buy, but you have only 20K. So you ask an investor to give you 80K in order to buy the house.

Then out of your pocket you have two payments to make:
1. Slowly pay off 80K on a 1-2-1 amount, so if you agree to pay it off in 80 years, you pay 1K a month only (nothing extra, so there’s no riba)
2. You would like to also live in the house over the time you pay off the 80 K over the 80 years, so you have to pay a rent. Given you own 20% of the house, whatever the market rent is for the house, you pay 80%. And it falls as your ownership increases, so in year 60, you only pay 20% worth of the market rent.

Would this be deemed to be halal? If so, why don’t these models exist?

 

[c2c]

@gilynn This model does exist. It is a form of “diminishing musharikah,” where one partner slowly buys out the other over a pre-arranged schedule. In paying rent you are basically a partner in the investment as well as a customer.

Many banks and companies around the world use this model. Including one of the main Islamic financing companies in the US.

 

[gilynn]

@c2c oh sweet. but how does Guidance Residence profit from this transaction?

And how do they calculate the rent of the home? is it comparable to other homes in the area or is it different implying a riba substitute?

 

[c2c]

@gilynn I gotta say if you just came up with this idea on your own that’s really quite clever of you!

As to Guidance: Their profit comes essentially from the rent or profit rate which is paid by you. As you’re getting at, the rental “rate” isn’t actually based on market rents but a rate that they offer that conveniently happens to be about the market rate of mortgage interest.

That said, there’s good reason for that (it’s more easily comparable to conventional mortgages for both customers and investors). And as far as I know, a missed payment is not added to the balance used to calculate rent (so you never pay “rent” on rent owed, which would be riba.)

 

[gilynn]

@c2c Haha I'm quite desperate to understand how I can buy a home, but its a waste of an idea if it doesn't work.

I understand that they need to provide a commercial product to the West, but thats very disappointing and why I would never use an Islamic Bank. I wonder how using market rent rates would change the picture in terms of profitability. I've just had a look at UK average rental yields and UK average Mortgage interest rates - I could be comparing apples and pears, apologies if so - but annual rental yields tend to be higher or similar to a 10 year fixed mortgage interest rate. With interest rates going higher, maybe it will be a tough ask on investors, but there is still money to be made, I don't understand why they wouldn't go for it. I guess buying a self appreciating asset could be for one like the guy above said, I'm not sure how you can stop that, perhaps you could place a ban for X years on the customer re-selling the home when they get to 100% ownership.

Are you aware of any other institutions that use or have used this model? I would love to see how they approach it. Or even any resources that talk about the different mortgage strategies/approaches in lending money/how money was lent in islamic history or history itself?

I would love to hear your thoughts on this: IMO, the biggest challenge is probably with the investors themselves. If they can be convinced that whilst they could probably gain more absolute profit with commercial mortgages, if they take into account a goodwill of 'helping the people' haha, there is wayyyy more profit in these types of mortgage models. Surely there is a particular genre of investors who care about society, theres so much dry powder nowadays, and take the cut in profit if necessary. Perhaps, Govts should get involved...

And absolutely, that is the beauty of Islam, it protects the customer from getting in a deep hole if they were to miss their rent one month. But surely Guidance Residence has some kind of mechanism in place to protect the investor e.g if customer misses rent for 6 months in a row, they sell the house and recoup their ownership %?

In terms of collateral, I assume from an Islamic POV that it would be okay for the customer to lose the part of the home they don't own? So if someone owns 20% but misses their ownership payment then it would be okay for the investor to sell the house and give 20% worth to the customer? They take the risk together?

Apologies for the ramblings haha, as you can see, I am super desperate/interested in finding a solution to this problem.

 

[jade2541]

@gilynn

I'm quite desperate to understand

Jazakallah khair for seeking out knowledge.

Are you aware of any other institutions that use or have used this model? I would love to see how they approach it.

In addition to points discussed in other comments, there is one important point in Diminishing Musharakah. If the investor's shares are guaranteed to be sold in 80 months at a guaranteed price, it is not compliant. Unfortunately, that is the case for most Islamic mortgages including Guidance Residential. One can review any company in terms of AAOIFI criteria using the checklist below. We have done it for a number of companies (did not get a chance to complete the review for Guidance residential yet).

https://www.reddit.com/r/HalalMortgageReviews/comments/rodyb1

if customer misses rent for 6 months in a row, they sell the house and recoup their ownership %?

The keyword here is "their ownership %". In the case of most Islamic finance companies, they will not recoup according to their % ownership but as per their initial investment like they have loaned not invested.

So if someone owns 20% but misses their ownership payment then it would be okay for the investor to sell the house and give 20% worth to the customer? They take the risk together?

Please share if you are aware of a company that does this way. I would like to review it in our community.

 

[tessla]

@gilynn This is the model that the shariah complaint mortgages use. In the UK al Rayan bank and Gatehouse bank offer these.

I’ve recently taken out one of these with gatehouse. Feel free to ask more

 

[gilynn]

@tessla wow, firstly congratulations!

so to be clear, with Gatehouse, you own X% of your house and the bank owns (100-X%). You're slowly paying the (100-X%) off whilst also paying the rent to stay in the home on a pro rata basis? If so:

How did Gatehouse calculate the rent element? Is it based on LIBOR or alternatives or is it based on the market rent ie similar to similar homes in your area?

With regards to the ownership element, is the valuation of the house solely based on the house fundamentals (ie Real Estate agent valued it) or did Gatehouse apply a mark-up on a 'profit' basis? How did Gatehouse come to the home valuation?

in terms of risk sharing, what mechanism is in place if God forbid the home burns down? Is there an insurance company used? Would the insurance company clear what the bank is owed?

How does Gatehouse make a profit?

What happens if you miss either rent payment or ownership payment? are you charged interest as a fine?

out of interest, was there a minimum/maximum in terms of the value of house you could look at? were they able to cover all houses in the UK or were you restricted to particular places? I only ask as given you purchase the home jointly with Gatehouse, I wonder if the bank has any say or cares in what house you can own?

was there a minimum deposit you had to pay? are you expected to own at least 20% of the home?

If you had time on your side, do you think you could of have paid for the house in one lump sum yourself? Ie saving/investing etc. I only ask as I'm 23 and I still have some time before I really need to buy a home, but its a big priority for me, so I wonder if looking back you regret not doing something or know of a strategy that could of have got you the property without the mortgage. I hate mobile phone contracts so a mortgage seems way worse.

Thanks in advance!

 

[tessla]

@gilynn Thank you! To be honest it came about in quite an unexpected way but alhamdulillah I am pleased I took the jump.

so to be clear, with Gatehouse, you own X% of your house and the bank owns (100-X%). You're slowly paying the (100-X%) off whilst also paying the rent to stay in the home on a pro rata basis?

I paid a 20% deposit so I own that much and the bank own 80%.

At the time I took it out, the rent was set at 3.94% and is fixed for 2 years. After this time period the rent is recalculated. It isn't set by area but will be determined at a rate similar to LIBOR.

With regards to the ownership element, is the valuation of the house solely based on the house fundamentals (ie Real Estate agent valued it) or did Gatehouse apply a mark-up on a 'profit' basis? How did Gatehouse come to the home valuation?

The house was advertised by the estate agent for X amount. I put an offer for X - 3K and the seller accepted. The bank then arranges a survey and for me fortunately the value was X + 10K so the bank was willing to go ahead with X - 3k. They will only purchase up to the value of their survey and not more but essentially no there isn't a markup.

in terms of risk sharing, what mechanism is in place if God forbid the home burns down? Is there an insurance company used? Would the insurance company clear what the bank is owed?

If the place burns down then my payments will stop, as you cannot rent out a non function place. This is what differentiates it from a conventional mortgage as I believe (but may be mistaken) that the interest continues to go up in this time. The bank have taken out an insurance policy which would cover costs / cost to rebuild.

How does Gatehouse make a profit?

I'm paying them rent for 20 years.

What happens if you miss either rent payment or ownership payment? are you charged interest as a fine?

Its only one payment that leaves my account each month. They say if you run into financially difficulties you should contact them as they may be able to pause the acquisition payment for a bit. If you don't contact them, I think there is a £25 fixed fee.

out of interest, was there a minimum/maximum in terms of the value of house you could look at? were they able to cover all houses in the UK or were you restricted to particular places? I only ask as given you purchase the home jointly with Gatehouse, I wonder if the bank has any say or cares in what house you can own?

I think there is a defined minimum. As for maximum that is based on your income. The bank assess your salary and outgoings and run affordability checks. I think the maximum is 4.5x your salary although in my case I did not go for maximum. I hear they do not operate in Scotland but I live in England so wasn't an issue.

The place has to be habitable, and if a leasehold property has to have a long enough lease to cover mortgage period. I think those are the main criteria.

was there a minimum deposit you had to pay? are you expected to own at least 20% of the home?

When I applied, it was a minimum of 20% deposit, however I believe since then they've also introduced 10% as well. Bear in mind, the multiples of your salary would have to cover the rest though. Al Rayan used to also have 10 - 20% deposits but with covid increased the minimum to 35%. Then a lot of people went over to gatehouse due to lower deposits.

If you had time on your side, do you think you could of have paid for the house in one lump sum yourself? Ie saving/investing etc. I only ask as I'm 23 and I still have some time before I really need to buy a home, but its a big priority for me, so I wonder if looking back you regret not doing something or know of a strategy that could of have got you the property without the mortgage. I hate mobile phone contracts so a mortgage seems way worse.

I live in London, so realistically to buy a property outright is not realistic for most people. What I have done, is not tried to reach for the stars and max out what I can get. But I have gone for something reasonable for me; which ended up being a 2 bedroom flat. To make it more financially worthwhile, I have agreed to a 20 year mortgage to reduce the monthly payments, but in reality I aim to pay it off in 10 inshallah. After 2 years, you are able to make extra acquisition payments, so that each month less of your money is going to the 'rent' and more to the 'ownership'.

I am probably not very financially savvy, and yes with investments you could also make money, but I am not too concerned about losing money with this particularly property as it is in a well located area and decently sized in London so I would imagine I would also be able to sell or convert it to a buy to let.

As Muslims I think we have been taught to be afraid of debt, but if I imagine I am borrowing it from my future self, then £10 now is worth much less in the future.

Hope this helps.

 

[onehumbleservant]

@tessla Thank you so much for this explanation. It was really helpful in understaning these Shariah compliant mortgages.

 

[jules1231]

@gilynn Its is halal but these model rarely exist because for the investor it's going to be a depreciating asset since the investor is locked into a selling price.. now think, instead of selling, the investor just bought and rented for the 80 months and sold after he/ she would make ton of a lot more money..

 

[gilynn]

@jules1231 but arent banks/financial institutions involved in a depreciating asset since they are also locked in a selling price?

 

[jules1231]

@gilynn Big difference from.your scenario.. apart from the compounded interest money they make.. the main difference is liability.. if the house were to get destroyed, in your case it would be a shared loss with the investor but with the banks they will have to paid even if it gets destroyed..

 

[gilynn]

@jules1231 instead of compounded interest, you can compound the pro rata rent payments?

in terms of liability, Im not sure how it works with Islam. If the house were destroyed, in my example, would the investor leave with nothing? If so, would it be okay to apply insurance to prevent that risk from ever happening?

 

[beardedyouthpastor]

@gilynn No risk sharing in the value of the house.

Binding purchase obligation based on monthly mortgage payments...quacks like a mortgage.

Therefore not compliant.