A Report On

Islamic Home Financing

Essential of Islamic Finance

Submitted by: Muhammad Nabeel Shahzad Siddiqui (3851) Syed Umair Waqas (3505) Saba Zuberi (3680) Nusrat Naqi (6755) Submitted to: Mauzzam Farooq
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Table of Contents
INTRODUCTION ......................................................................................................................3 CRITICAL ANALYSIS OF CURRENT ISLAMIC HOME FINANCING ..................................3 MODES OF ISLAMIC FINANCING USED IN MARKET ........................................................4 PRODUCTS OF DIFFERENT BANKS OF HOUSE LOANS: ...................................................4 1. a) 2. a) b) 3. Participatory mode ...........................................................................................................5 Musharakah ..................................................................................................................5 Trade based (Murabaha) ...................................................................................................5 Cost-plus sales ..............................................................................................................6 Credit Sales ...................................................................................................................6 Rental based .....................................................................................................................6 a)Ijarah ................................................................................................................................6 HOW TO OBTAIN A HOUSE FROM ISLAMIC BANK ...........................................................7 DOCUMENT REQUIRED FOR HOME FINANCING: .............................................................8 Customer Eligibility Criteria (Dubai Islamic bank) ..................................................................8 Pakistani National. ............................................................................................................8 Pakistani National residing in UAE. .................................................................................8 LIST OF ISLAMIC BANK DEAL IN THE HONE FINANCING: .............................................9

INTRODUCTION:
A Beautiful home is dream of every person. To fulfill this need people normally spends their all reserves and savings but those people who have no any saving and funds to get a sweet home they will hire homes or get money on credit for purchasing or building a home. People normally not approach their relatives for such a long term financing. They will go to the financial institution to fulfill their needs. There are different substitutes available for getting finance for home. Conventional Banks provide financing for building a home on the basis of Interest/Riba. But Modern Scholars introduced some Shariah compliant methods of home financing which are using in all over the world in Muslim Communities. In home financing using declining equity ownership structure, the customer approaches the bank for joint purchase of an asset/property. The seller of the property is paid by the bank and the bank and the customer enter into a Joint Property Purchase Agreement. In this arrangement, the ownership stake of the tenant increases and that of the bank decreases or diminishes with the passage of time. The rent decreases as the ownership stake of tenant increases. The share of the bank in asset/property is divided into units. These units are purchased by the customer periodically until he/she has purchased all units and become the sole owner of the asset/property. Rent is not charged immediately and is charged at the end of the month for the use of asset/property. Rent for at least one period is fixed. Unit price fixed for a period is not changed during that period. The rent is calculated based on 1 year LIBOR. The floor rate (minimum rate) and the ceiling rate (maximum rate) are stated based on which the rentals rate can vary. In agreement, it is stated that if payment is made on time, the transfer of ownership will take place accordingly. The risk of damage to the property is borne by the bank and the customer, according to the stake in the property at the time of loss due to accident. Just like in conventional mortgage, a penalty is charged if a customer withdraws from the contract that is paid to charity. The logical argument presented for such a penalty is that the contract involves a promise/undertaking to pay rent and purchase units of the asset/property and if a customer withdraws from the promise/undertaking, he/she can be asked to pay a penalty for maintaining financial discipline. The penalty cant be taken as income by the bank because change in price after the execution of sale cant be made as per Islamic scholars. That is why; the penalty collected from customers is paid to charity.

CRITICAL ANALYSIS OF CURRENT ISLAMIC HOME FINANCING

In home financing using equity ownership concept in Islamic finance, two contracts i.e. tenancy and sale are included as two separate components of a contract. Both these contracts are separated by way of a unilateral undertaking in place of the actual simultaneous sale/purchase of units of the asset/property. Upon close inquiry, one can notice that unilateral undertaking or promise makes the contract conditional. This argument is further substantiated by the fact that if
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the client refuses to undertake or promise to buy the asset (in units), the bank will not make contract with him/her. Furthermore, the promise gives the legal cover to the bank and is acceptable in a court of law. Fiqh Academy rendered Organized Tawarruq impermissible, but the unilateral undertaking in almost all prevalent Islamic finance contracts - including Murabaha, Ijarah, Diminishing Musharakah, Salam, Istisna, Musawamah etc - is an organized way of avoiding price and market risk (the only relevant risks and the only dividing line between trade and lending for interest). Hence, with the same logic, OIC Fiqh Academy should have rendered unilateral undertaking an organized tool for avoiding price and market risk and the Fiqh ruling of no return without taking risk. Options in Islamic finance are not allowed due to the ruling that transactions should be Gharar free i.e. free from ambiguity and uncertainty. In the opinion of this author, the concept of Gharar (uncertainty) should not be used as a shield to avoid price/market risk. 1400 years ago, the economy was agricultural and the agricultural yield was not predictable and homogenous. In Options contract, the obligation rests on one party and the other has an option. Therefore, it does not have any element of Gharar (uncertainty). Call premium is also charged to create financial discipline. If there is no call premium, then one will buy an unlimited number of options contract to hedge for each date for a same or similar price. Hence, options could be used in fixed asset/property financing to separate sale and tenancy contracts. In the practiced Islamic banking, taking an undertaking from the finance is just like buying a put option from the finance who is acting as a put option writer. If this is reversed, the finance would buy the call option and the bank will sell the call option i.e. acts as a call option writer.

MODES OF ISLAMIC FINANCING USED IN MARKET

Modes of financing in Islamic banking are those which are permissible by Shariah, and for this there are three modes through which there is no element of interest.

PRODUCTS OF DIFFERENT BANKS OF HOUSE LOANS:

Following are the products which are currently in used by different Islamic Banks in Pakistan 1. Participatory Mode a. Musharaka b. Mudaraba Trade Based (Murabaha)
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2.

3.

a. Cost-plus b. Credit Sales Rental Based (Leasing) a. Ijarah Participatory mode is a kind of partnership where partner involve in business. One partner gives money to another for investing in any profitable avenue which is acceptable by Shariah.

1. Participatory mode

a) Musharakah 1. Commonly used contract, where Bank and the customer share the ownership of real estate. 2. This contract is known by many names; most prominent among them is the name musharaka (diminishing partnership). 3. In contrast to the leasing model, where ownership of the financed item remains with the lessor for the entire lease period, ownership in a diminishing partnership is explicitly shared between the customer and the Islamic Bank (legally, what is established is an Islamic Shirkat-ul-Milk. 4. The periodic payments of the customer in this model contain two parts: I. A rental payment for the part of the property owned by the Islamic financial institution. II. A buy-out of part of that ownership. Over time, the portion of the asset which is owned by the customer increases, until he owns the entire asset and needs to pay no more rent. Diminishing Musharka It is a participatory type of financing in which a partner buys the share of the partner gradually until the ownership of the asset is completely transferred to the client. Brief Explanation 1. The client wants to purchase a house for which he does not have adequate funds. He approaches the financier who agrees to participate with him in purchasing the required house. 20% of the price is paid by the client and 80% of the price by the financier. 2. Thus, the financier owns 80% of the house while the client owns 20%. After purchasing the property jointly, the client uses the house for his residential requirement and pays rent to the financier for using his share in the property. 3. House divided in eight equal units, each unit representing 10% ownership of the house.

2. Trade based (Murabaha)

It is a way of financing in which Islamic banks provides financing through sale and purchase of commodities.

 It is a secure mode because they create debt and payables upon debtors/customers. An Islamic bank buys a commodity (directly or through its agent) from the market and sells it to customers on deferred payment basis (instalments). a) Cost-plus sales i. In this sale, the buyer knows the price at which the seller obtained the object to be financed, and agrees to pay a premium over that initial price. ii.It was narrated that Ibn Masud ruled that there was no harm in declared lump-sum or percentage profit margins. Thus, one may approach an Islamic Bank and say Purchase this item on my behalf at this price, and I shall give you a profit margin of PKR100, 000, or Purchase this item on my behalf at this price, and I shall give you a profit margin of 10%. b) Credit Sales i. This sale is rarely used by Islamic banks with the price paid immediately by the customer. In such cases, there would be no financing included, and the Islamic bank would simply be a middle-man or broker-agent. ii. When a customer approaches an Islamic bank to finance a purchase through murabaha the payment of the price is usually deferred, and most commonly paid in instalments. iii. Indeed, the murabah component determines a Profit margin (even as a percentage of the original price) iv. A price is increased if it is deferred Hashiyat Ibn Abidn

3. Rental based
Rental based financing is giving something to other for use against a fee or rent or fare, so it is act of giving a physical thing to other person for use against a return (rent or fee). Rental based does not include employment activity or service performed by a person. a)Ijarah i. Ijarah, implies leasing or hiring a physical asset. ii. It is a popular product in which the Islamic bank assumes the role of a lessor (aajir) and allows its client to use a particular asset that it owns. iii. The lessee (mustajir) receives the benefits through Ijarah associated with ownership of the asset against payment of predetermined rentals (ujrat). There are two famous types of lease.

i. lessee.

Operating Lease This lease allows using an asset but does not convey the rights of ownership of asset to

Finance Lease A lease contract that allows the use of an asset and considered to have the characteristic of ownership during the period of lease and automatically convey rights of ownership of the asset to lessee at the end of lease period. Islamic financial system recognizes only Operating Lease while finance lease is not allowed. In addition, this sales requires a promise by the lessor that he will agree to sell the leased object at the end of the lease at a pre-determined residual value. The above mentioned all methods are all valid according to Shariah if we summaries the above mentioned all modes of financing so we can say there are mainly three Islamic modes of financing for home financing i.e. Murabha, Ijara and Diminishing Musharkah. Diminishing Musharkah is more acceptable Islamic mode of financing than other. Out of these modes of financing Murabha for Islamic Home financing is disapproved by the scholars. Middle east Shariah scholars rejected this mode because this is same as conventional mode of home financing (Meera and Abdul Razak). Ahmad Tarmidzi writes in his thesis dissertation that Bay Bithaman Al Ajil for home financing is same as Bai Inna. Because the practice of BBA financing is same as Bai Inna i.e. Bank purchases home from client e.g. for PKR 100000 and will sell to him at cost plus profit like (100000+10000=110000). So this practice is same as Bai al Inna. So this mode of Islamic home financing is most controversial between scholars many scholars like meera and Abdul Razak has totally rejected this mode. On the other hand Diminishing Musharkah/MM is most acceptable in scholars for Islamic home financing in all over the world. Home financing is the combination of three contracts (Partnership + Ijara + Sale)

ii.

HOW TO OBTAIN A HOUSE FROM ISLAMIC BANK

You will approach Islamic bank and inform about your needs of financing for Home Purchase, Construction, Renovation or Balance transfer facility you will then submit the filled Application Form along with the required documents and a cheque for processing fee. Our Business Executive will guide you during the whole process. The Bank will conduct verification of your residence & office addresses as well as those of the references provided by you The Bank will then conduct your Income estimation to determine the maximum financing that can be provided to you. In case you are Self Employed, our agent will approach you for the necessary income details and documents. In case you are Salaried, we will approach your employer for this purpose A legal opinion is then obtained by the Bank on the property documents submitted by you Valuation of the property is done to determine its Market value, The Bank then issues you an offer letter for the financing amount you qualified for based on your evaluation After your acceptance, a Shirkat-ul-Milk (Musharaka) Agreement is signed between you and the Bank, whereby, the Bank and you will become joint owners (partners) in the Musharakah property.
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A Pay Order is issued in the name of the seller in case of MUSKUN Home purchase by the bank. Youre Business Executive and our in house / External lawyer will accompany you for the transfer of property in your name. The Pay Order is then handed over to the seller. In case of MUSKUN Home Construction / Renovation / Replacement Cases, the financing amount is simply credited to your account. It is ensured through Shariah-compliance checks that the funds are utilized only for construction/renovation/replacement. You and the Bank now jointly own the home You and the Bank also execute a Monthly Payment Agreement whereby you agree to pay a monthly payment to the Bank for the use of the bank's ownership in home Undertaking to Purchase is given by you, under which you undertake to purchase the Musharakah Units (representing Bank's undivided ownership share in the property) from the Bank periodically. On monthly basis, you purchase Musharakah units from the Bank When you have purchased all units of Bank, you become the sole owner with a free and clear title to your home

DOCUMENT REQUIRED FOR HOME FINANCING:

Copy of primary applicants CNIC. Copy of Co-partners CNIC, if necessary. 2 Passport Size Photographs. Tax Returns. Copy of Utility Bill. Professional Degree (for self employed professionals only). Salary Certificate/Proof of Profession. Latest Salary Slip. Bank statement of the last 12 months & Bank Certificate.

Customer Eligibility Criteria (Dubai Islamic bank) Pakistani National.

Age 25-65. Minimum monthly net income of Rs.40,000/-. Self-employed Businessmen/Professionals or Salaried individuals. Property Eligibility Criteria The qualifying property must be located in Cities (Karachi, Lahore, Islamabad, Rawalpindi and Faisalabad) of Pakistan.

The minimum value of the property must be greater Customer Eligibility Criteria (Overseas Pakistani - UAE only) Pakistani National residing in UAE. Age 25-65. Minimum monthly net income of AED.25,000/-.

than

Rs.2,000,000/-.

Self-employed Businessmen/Professionals or Salaried individuals. Property Eligibility Criteria The qualifying property must be located in Cities (Karachi, Lahore, Islamabad, Rawalpindi and Faisalabad) of Pakistan. The minimum value of the property must be greater than Rs. 2,000,000/-.

LIST OF ISLAMIC BANK DEAL IN THE HONE FINANCING:

BankIslami Pakistan (Muskun Home) a) Shirkat-ul-Milk (Musharka) Burj Bank a) Dimnishing Musharkah Meezan Bank a) Dimnishing Musharkah Bank Alfalah Al Baraka Bank a) Murabaha Financing Dubai Islamic Bank MCB Islamic Banking Standard Chartered Islamic Banking Askari Islamic Bank