Most people work hard at earning a living but are unable to buy assets such as homes and automobiles without financing. Also for entrepreneurs who wish to start a new venture or expand an existing one financing is essential. The world of banking and financing has rules and regulations that need to be followed in order to get financing for a home, business or automobile. Certain religions such as Islam have strict rules when it comes to financing and lending. For people living in Islamic nations there is little trouble with getting financing without breaking any religious laws. But for those living in non-Islamic states it is a different matter. Muslims in USA need Islamic financing that will help them achieve the goals that they want to whilst maintaining the sanctity of their religious beliefs.
Those who devour usury will not stand except as stands one whom the Evil One by his touch hath driven to madness. That is because they say: "Trade is like usury but Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord desist shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (the offence) are companions of the fire: they will abide therein (for ever) 2: 275 Quran
O ye who believe! fear Allah and give up what remains of your demand for usury if ye are indeed believers. 2: 278 Quran
Islamic banking is based on the principles of the Sharia and the basic tenets of Islam do not allow its followers to take on certain kinds of financial transaction such as loans with interest. The financial needs and requirements of Muslims in the USA are quite similar to any other American’s. They want to buy a home, start a business, expand their company or buy an automobile. However often the basic features of conventional banking restrict them from seeking financing. USA based Islamic financing options are becoming popular by the day. These institutions allow Muslims in the USA to seek financing without having to worry about breaking Islamic laws and rulings. At the same time a contract is considered as just a contract and this is also true to Islamic financing. While there are those who have only basic knowledge of Islam and wonder how financing can be permissible in the religion, as ‘riba’ or interest cannot be levied and if Islamic financing options are a practical consideration. To understand the USA based Islamic financing options it is important to first understand the basics of this financing alternative.
The purpose of Islamic financing remains the same as for conventional financing and the only difference being that it based on the Fiqh al-Muamalat or the Islamic rules on transactions. The two main principles of Islamic banking are the prohibition of riba or interest and sharing of profit and loss. The main features of Islamic financing include the fact that the Quran does not allow its believers to accept, charge or witness a financial deal that incurs interest. Thus lending or borrowing money has to be free of interest. The Sharia law, which guides moral conduct in Muslims, considers income that carries an interest and debt as immoral. However modern Islamic financing allows negotiated profit margins and fees. In conventional banking capital guarantee is essential while Islamic financing does not always provide capital guarantee for all its deposits. However times are changing and so is Islamic financing and while it does offer zero interest, it also provides capital guarantee, thus making it more acceptable in the contemporary world of finance. This is especially significant for Islamic financing in non-Muslim countries and makes things easier for resident Muslims.
When it comes to investments and loans, Islam does not allow the charging of any interest. In contrast in conventional banking when the bank customers deposit money they are assured not only the capital they have deposited but also interest on that sum. Also when banks offer loans they do so on the condition that the capital will be returned along with interest that will cover the costs of the transaction. In Islamic financing there is a distinction between lending and investing. In case of loans there will be no interest charged and capital will be guaranteed. While investments are made on a profit and loss sharing basis. Thus lending and investing are distinguished from each other in Islamic financing. Thus to make a profit on their deposits clients have to invest or participate in financing a project. For those investors who wish to earn a return on their deposit Islamic financing offers the concept of participatory financing. This is also termed as ‘mudaraba’, and involves profit sharing and loss absorbing scheme. In its simplest form participatory financing involves two parties, one that is ready to finance a project and the other that has the knowledge and technology to give shape to the project. In case the project is profitable it is shared and when losses are incurred they are borne by the financer.
Essentially banks have two basic purposes, firstly the transfer of money between accounts and the second is money lending. In Islamic financing money transfers and current accounts are interest free. Every aspect of banking and related financial transactions is studied to ensure that ‘riba’ or interest is avoided. When it comes to the interest charged to the borrower of a loan the so-called interest is considered as cost of borrowing the money. This includes service costs, decrease in the value of the capital due to inflation, etc. The funds of the depositors are utilized for investing in various projects and businesses and the profit from these are shared with the depositors. The rate of return is not fixed in Islamic financing.
Some of the common terms in Islamic financing that people seeking financing for homes, automobiles or businesses include the following:
- Bai’ al-Inah is the sale and buy back agreement that allows Islamic financial institutions to first sell an asset to an investor and then buy it back immediately for cash and at a discount. By buying back the asset the financier has ownership over the asset in case of default in payment and also this does away with the issue of charging interest.
- The Bai’ Bithaman Ajil allows the deferred payment on a sale. This essentially relates to the deferred payment towards sales of goods at a profit agreed upon by both parties and involves payment of debt in a single installment.
- Bai muajjal is basically a credit sale and works on the same principle as the Bai’ Bithaman Ajil and allows repayment of the debt in a one time payment or in several installments. It also has a margin of profit that is decided with the consent of both parties involved in the financial transaction.
- Baihaqi Kasi Salam refers to the advance payment for goods that would be delivered at a later date. The terms of the transaction require that the quality of the goods be specified in great deal in order to avoid disputes. Also only goods can be bought and sold under Baihaqi Kasi Salam and not commodities such as gold and silver.
- Hibah is a voluntary token or gift that may be paid by the debtor to the creditor and could be in the form of interest paid by the financiers to savings accounts.
- The Islamic financing concept that deals with usufruct and the return that is decide for the proposed use and profit from the asset is known as Ijarah. Therefore it deals with the rent that is to be paid for the use of the property of another.
- The Ijarah Thumma Al Bai' deals with the lease and purchase transactions that allow financer to first lease an asset and then at the end of the lease contract sell it to the individual. The contract thus allows the financier to charge a price higher than the market value for the service of being able to defer and divide the payment into several installments.
- For Islamic financing for the construction of roads, bridges, etc, Istisna’a is an agreement that allows cash payment in advance for goods that will be delivered in the future.
- Mudarabah allows the financer and the entrepreneur to make a joint effort in a project in which the profits are shared while the financer bears the losses, if any. Until the loan is paid of the profit sharing continues. For its time value of the money the bank is provided with interest.
- The Murabahah is related to the sale of goods at a pre-determined price agreed upon by both parties. An example of Murabahah is the fixed income loan wherein the rate of return for the time value of the money is decided at the start of the contract.
- Qard Hassan or as the good loan requires the debtor to only pay the capital that they have borrowed. However they may also choose to pay an extra amount to the financer on a voluntary basis.
- Wadiah relates to the money deposited for safekeeping in the bank and it may also be awarded a hibah if the bank so chooses to.
In the USA Islamic financers such as American Finance House: Lariba, the oldest Islamic financial institution in the USA and MSI or Muslim Savings and Investment Finance Service Corporationprovide their clients and investors with many financing options. Also certain banks such as Devon Bank and University Bank also offer Islamic financing. The Neighborhood Development Center and World Relief are small non-profit organizations that offer Islamic small business financing. Also financial entities such as SHAPE Financial and Reba free also offer Islamic financing products.
Islamic Financing for Home Financing
A home is the sanctuary that provides shelter not just from the elements of nature but also provides a psychological and emotional blanket against the outside world. Islamic financing institutions can help Muslims in the USA bring alive their dream of owning a home. The model for home financing that is used by Islamic financers in the USA is that of lease to purchase or the Ijara Wa Iqtinaa or Diminishing Musharaka. Musharka means the joint partnership between two or more people, wherein both the profit and loss are shared proportionately with the amount of investment made by each partner. It is a mutual contract between adults who enter the contract of their own free will. The partnership may involve active participation by each partner or could also involve ‘sleeping’ partners. In home financing diminishing Musharka translates into diminishing partnership. This means that the individual first leases the home from the bank or financial institution and when this contract comes to an end they enter another contract to purchase the house. Thus to start with the bank or financier owns the home and rents it to the individual who pays ‘rent’ for the accommodation, the rent is decided mutually according to the market value. Thereafter any amount paid above the required rent would increase the ownership of the individual.
A demonstration of home financing with Islamic financing is as follows:
If a person wishes to buy a home that costs $150,000 then he would first have to make a down payment to the bank or financial institution. The down payment required ranges from 20% to as low as 5% of the value of the home. The bank pays the rest of the due amount. Thus now the bank and the individual own the home in partnership, with the bank holding a higher stake in the home. As the individual pays the rent for using the home and increases this amount his or her stake in the home increases until it is owned completely by them. The rent is decided according to estimated amount for properties in the same locality. The individual pays rent for the bank’s share of the holding. For instance if the bank owns 80% of the home and the rent for such a home in the neighborhood is $1,000 then $800 has to be paid as rent.
In cases where rent hasn’t been paid or is late the bank can charge a penalty but as this may also be considered a interest the bank would have to carefully evaluate each case and as for the penalty to be paid as charity. The transaction for home financing using conventional loan or mortgage documentation that satisfy the existing banking and financing regulations in the USA.
Home Construction Financing by Islamic Financing
For those who wish to construct their own home according to their own plan and specification financing can be sought from banks. It is possible to construct your own home with the help of Islamic financing in the USA. For this it is necessary for the individual to first buy the land by himself or herself before approaching an Islamic bank or financial institution for financing. The design and construction are discussed with the financing company and the builder needs to have experience in construction in the same neighborhood. There are two ways by which home construction financing can be organized, firstly it can be a joint venture between the client and the financial company and this would involve a joint agreement or Musharaka. According to this agreement the client owns the land and the bank or institution invests the money for the construction of the home. Profit and loss is shared between the two partners and there is a schedule and timetable for the manner in which the money is used for the construction. Once the home is built the construction financing contract can be converted into a home financing one and the lease to purchase model will be followed. Thus initially the client will pay a rent and slowly will be able to buy the bank’s share in the home and ultimately own it.
The other option is the Cost Plus or Murabaha agreement. According to this trade financing for the construction material can be done. Thus the bank or financier buys the goods required for construction on behalf of the client, who agree to pay for the goods and a profit is decided beforehand.
Islamic Financing for Automobile Financing
Clients can get Islamic financing to buy an automobile. According to Islamic financing when financing for a car or automobile is sought the rate of interest is not a consideration. The start point of the transaction is the evaluation of the value of the vehicle that is to be purchased. The client is encouraged to research the estimated rental value for the car or for a similar automobile and the bank also takes on a similar evaluation. By doing so the utility of the car in current economic conditions is assessed. Thereafter the automobile is bought together by the individual and the bank. The down payment paid by the person is considered as his share of investment while the bank pays the rest of the amount that is required. To keep with conventional banking and loan procedures in the USA the title to the automobile belongs to the client. The client pays the rent for the car and slowly buys out the financial entity’s share in the car, this is also referred to as the Repayment of Capital. The lease or rent paid is termed as Return on Capital. At the start of the automobile financing transaction it is determines as to how much of the monthly payment is Return on Capital and how much is Repayment of Capital.
Islamic Financing for Start-up Businesses
For a person or persons who wish to gain from business financing from an Islamic bank or institution it is required that the individual or individuals have at least 3 years of business experience and wish to associate with branded names and services such as gas and service stations like ARCO and CITGO or restaurants such as KFCs. There are two ways by which business financing is handle the Islamic way. Firstly the client may enter a joint venture with the financial company wherein both own a certain amount of the business and the client pays a business fee. The profits and losses are shared and the client has the right to purchase the business after a period of time.
Secondly the lease to purchase agreement can also be used for a joint venture between the client and the bank or financial entity. Thus the client pays the lease for the use of the business and with additional payments is able to buy the business. Once again the amount of money paid as rent is considered as the Return on Capital while the additional payments made above and beyond the lease value is termed as the Repayment of Capital. Both of these are a part of the monthly payments and are decided in the initial stages of the transaction.
Trade Financing by Islamic Financing
Whether it is for expansion or to buy goods every business, big and small, requires loans for various purposes. The Islamic financing model provides such financing with Murabaha. Cost plus or Murabaha allows clients to get financing to buy goods and the bank or financial institution does so on behalf of the client. The client uses the goods and pays a pre-determined price to the bank, and this price is not related to interest. The person also pays a profit to the investing financial entity.
Equipment Financing by Islamic Financing
Often businesses find themselves lacking in capital that is required to buy essential equipment that would help in the growth and expansion of the business. Islamic financing in USA offers equipment financing that can be used to buy different types of equipment. Equipment financing involves a lease to purchase agreement. The client pays a rent on the use of the equipment that is primarily owned by the bank or company. The payments made by the client include Return on Capital, which is essentially the rent, and Repayment of Capital that allows the client to slowly buy back the equipment. The contract hence shifts from a lease to a purchase contract. The Return on Capital or the rent is decided on the economic value of the equipment and is decide after both the company and client independently assess the value of the equipment in the real world.
To comply with the U.S. regulatory requirements and the U.S. banking system rules the monthly payments made towards any financing agreement is calculated according to an amortization program to calculate the implied interest on the transaction. Some of the advantages of Islamic financing options in the USA include the fact that they allow Muslims to take on financing without having to break religious laws. Such financing allows them to buy and build homes, purchase an automobile, invest in a new business or use financing for buying equipment that is essential for a business. Islamic financing takes a practical and realistic view of the economic situation that surrounds the client and the purpose for which the financing is being undertaken.