The Ruling on the Permissibility of Financing Properties using Islamic Ijara Mortgages
(as implemented by HSBC and other banks in 2004)
Many people have enquired about the permissibility under shari'ah of the so-called Islamic ijara mortgages recently announced by banks such as HSBC. As it is in the interest of all Muslims to have a current and accurate understanding of the issues involved here, I have concluded the following judgement based upon the Qur'an and sunnah in accordance with the understanding of the main school of thoughts.
Let me first brief the reader regarding the manner in which the scheme works.
Under the ijara (rental) variety of Islamic mortgage, the bank purchases a property selected by the client, following a promise from the client that he or she will live in that property and purchase it after an agreed period of time. In return, the client pays monthly installments to the bank, mainly composed of two payments. One portion of the installment is considered to be a payment of the purchase price for the property, and another portion is counted as rent that the client pays for living in the property in the meantime. The purchase price paid by the client is equal to the purchase price initially paid by the bank for the property. Once the client has paid all of the installments, in other words the purchase installments plus the rental installments, the bank will transfer the ownership of the property to the client. The bank makes its profit from the difference between the price it pays for the property (including related transaction costs) and the amounts received in installments from its client.
This type of scheme, with some minor modifications, is used in the United Kingdom by HSBC Amanah Finance, Ahli United Bank and United National Bank. [cited Dec 09, 2004]
In principle, an ijara scheme can be structured in such a way as to be acceptable under shari'ah so long as certain conditions are met, the discussion of which is beyond the scope of this judgement. However, the implementation of the scheme by the above banks is highly problematic.
Firstly, the contract is ambiguous in terms of its nature. Is it a lease contract, a purchase contract or a combination of the two? Some scholars have prohibited combined contracts (for example, a transaction that combines both lease and purchase), as the Prophet, peace be upon him, prohibited two transactions in one transaction. This is the opinion adopted by most of the scholars, and although there are some who have allowed this type of transaction under certain strict conditions, there is a consensus that the presence of a significant amount of ambiguity invalidates a contract. Among the many Prophetic traditions on this point is that of Ibn 'Umar, who related that the Prophet, upon whom be peace, forbade sales that involve uncertainty or gharar (ambiguity). [Narrated by Muslim]
Many scholars, including the foremost fiqh councils of our times (see, for example, resolution no. 110 (4/12) of the Islamic Fiqh Academy (IFA) which is a subsidiary body of the Organization of the Islamic Conference (OIC)), believe that if rental and sale are mixed in such a way that one cannot distinguish at any point of time whether the client is a tenant or a buyer then such a contract is invalid according to Islamic jurisprudence.
When pressed to clarify the nature of the ijara mortgage, staff in Islamic banking departments frequently describe it as a 'lease ending in a purchase'. Yet if this really is the case then the ijara mortgage should display the features of a lease throughout the entire time-span of the contract (often as much as 25 years) until it concludes with a purchase event. In other words, the bank will rent the house for a period of time with the promise that it will sell to the client at the end of the tenancy. During the tenancy, the bank will be the legal owner of the property. After the tenancy the client will be the legal owner.
Although many scholars do not allow this type of combined contract, let us for the sake of argument consider it to be valid according to the opinion of those scholars who accept it. When we examine the available ijara schemes more closely, we find that the theoretical structure outlined above does not exist in practice. The ijara contract as it stands is neither a lease nor a purchase. Rather, it is closer to a conventional loan where the bank lends money to a client for a property purchase, and requires that the client must repay with a markup (under the guise of ‘rent’).
Consider the following questions which illustrate the ambiguity of the contract:
- Why does the tenant need to pay a large down payment? (Frequently an amount equal to 10% of the price is required. A genuine tenant does of course make some kind of down payment, relevant to the period of the tenancy, but no credible tenancy agreement can bind the tenant to place such a large down payment.)
- Who pays the insurance of the house? Is it the bank or the tenant? (Technically, the owner of an asset is the one who should pay for its insurance.)
- What will happen if there is loss or damage to the property and the insurance company refuses to cover the losses incurred? Who will pay for this? (Once again, if the bank is the actual owner, and such a loss or damage occurred through no fault of the client then the bank cannot hold the client responsible for damages.)
- If the tenant decides to stop the tenancy agreement, the bank will sell the property. If the price of the property has depreciated in the meantime (which means the bank as the owner of the property suffers a loss), why is the client bound to compensate that entire loss while being only a tenant?
- The point of all these questions is to address the central issue, namely, who is considered the actual owner (and thus liable for any damages or depreciation in value) for the duration of the lease? Is it the bank (in which case all of the above scenarios do not make sense), or is it the client (in which case this contract is not a lease contract in the first place, but rather something else)?
A bank may give an answer to all or some of these questions, supported by quotations from jurists past or present. Some of these answers may indeed prove to be acceptable when looked at in isolation but, when taken as a whole, such practices may invalidate the contract.
To illustrate our point, the bank might state that, according to a particular school of thought, the down-payment is not a part of the price of the property since it is not a purchase agreement. Rather, it is an assurance that the tenant is serious in renting the property for a given period of time (up to 25 years, perhaps). Such a condition is acceptable according to some jurists. Furthermore, the bank may state that the insurance is paid by the tenant based on a mutual agreement, and there is nothing wrong with such a condition, for the Prophet, peace be upon him, said:
"Muslims are bound to the conditions taken on by themselves."
In the meantime, they might claim that they are bound by English law to hold the title of the property, and will only pass it to the client upon the final payment. However, the contractual agreements that are signed between the bank and its client put all of the risks of ownership upon the client, and these factors defeat the purpose of ijara, even if technically speaking the bank claims to follow the letter of the English law as the 'owner' of the property.
In the above we see arguments that are each, on their own, widely considered to be valid. However this should not lead us into the grave error of assuming that three valid matters when combined produce a valid outcome. Take, for example, the plain riba transaction, but in the following framework:
- An interest-free loan, (which is something recommended)
- A gift, (which is again, something recommended)
- A promise
Taken individually, these three transactions are completely valid. However, if they are combined in a single contract, the result is pure riba. For example, I say, 'Grant me a loan which I will repay you (a valid matter), and I promise you (a second valid matter) a gift (a third valid matter) in addition to the repayment when it becomes due'. Is this contact valid or is it riba? The answer is that it is manifest riba without any doubt, since the one who gave the money was promised that same amount back along with some profit.
So, we need to look at the end-to-end process here and evaluate it as one transaction. And we need to answer the critical question: who is the real owner of the property during the whole process? Is it the client while the bank is just financing the deal as it does in a normal conventional mortgage? Or is it the bank? If the owner is the bank then does a real owner free himself from any responsibility towards his property? Why does the bank avoid owning the property?
Here, we need to explain an enormously incorrect methodology in deriving Islamic verdicts. A verdict should be derived by looking at a matter in its totality, in light of the aims behind it. When we break the matter of discussion into sub-issues and treat issues separately, without looking at the overall picture then we are contradicting the right methodology in deriving verdicts. The reason is very simple: verdicts based upon sub-issues might not necessarily be the same as verdicts based upon a consideration of the general situation.
A very good example is the previous one. Each sub-contract taken individually is completely valid, but taken as a whole the entire contract becomes null since it is a clear riba transaction. Based on this, many if not all jurists forbade contracts which try to employ such deception.
As another example to further illustrate our point, let us look at the transaction known as 'iynah. This transaction is strictly prohibited by the Prophet, peace be upon him, and its prevalence is a sign that the Muslim 'ummah will decline. The Prophet, peace be upon him, said:
"When you trade with one another with 'iynah, and hold on to the tails of oxen, and are content with farming, and give up jihad, Allah will cause humiliation to prevail over you, and He will not withdraw it from you until you return to (your commitment) to Islam."
This transaction, when broken down into individual parts and examined solely upon these parts, appears to be valid. However, when taken as a whole, it is clearly a type of riba.
How exactly does 'iynah occur? One of the means of practising 'iynah is that one party sells a product to a second party on a deferred payment. The second party then sells it back to the seller at a lesser price, but in cash. If you break this transaction into sub transactions you can conclude that there are two acceptable sale transactions. It is allowed for a person to sell a product for a deferred payment, and it is also allowed to buy a product for cash. However, the ultimate aim of this transaction is to enact a pure riba transaction. This is because the second party receives an amount of cash from the first party and is then required to pay back an amount of greater value at a later time. As for the product itself, since it changes hands twice, it returns to the initial 'seller'. Therefore, the product is used merely as a loop-hole to avoid the prohibition on riba.
This clearly illustrates that we cannot ignore the total aims of any transaction. Jurists mention this rule as a principle (qa'idah) that is employed for all business transactions. This principle states:
"The consideration of a transaction is to be paid to its intention rather than its format."
"Transactions are judged according to intention."
Of the evidences for this principle is the hadith of the Prophet:
"Actions are judged according to intentions."
It is true that some people might say that scholars disagree with this concept, but those scholars who disagree with this concept (like Imam Ash-Shafi'i), agree with all other scholars that the aim of the transaction should not be to overcome a prohibited transaction. In other words, all scholars are in agreement that it is sinful for two parties to try to devise a scheme that appears to make permissible something that the shari'ah declares impermissible.
I therefore conclude that there is no significant difference between the ijara scheme outlined above and the conventional mortgage which is a pure riba based loan. Under the ijara scheme, the bank performs what is essentially a money lending transaction, placing such conditions upon its clients that guarantee, for all practical purposes, that it will obtain the same amount of money in return plus a profit disguised as 'rent'. It might be true that many of the individual clauses and conditions of the contract are permissible (or, at best, subject to a difference of opinion among scholars), but when put together and examined as a whole, it is apparent that there is little that separates this contract from a simple mortgage. Of the many matters that clearly illustrate this is that the risks and rewards of ownership of the house are carried by the tenant, not the bank, regardless of who is the 'paper-owner' under English law.
Allow me to provide a real Islamic scenario for acquiring a house, and also mention a philosophical and ideological approach in explaining a very important principle in Islamic finance. If two or more parties enter a business transaction then of course their ultimate aim is profit. Islam, being the religion of ultimate justice, does not confer advantage to any party based on one’s worldly and materialistic power. In other words, in a permissible Islamic transaction, a powerful, richer person will not have any guaranteed advantage over a powerless, poor person. Both parties have to share the same risk of loss, just as they want to share the joy of profit. This is a very logical and simple – yet powerful – principle, which is an explanation of the Islamic rule:
'There shall be no profit without (a risk) of loss.'
This principle is based on many Prophetic traditions such as:
"It is not permissible to sell something on condition that the purchaser lends you something. And it is not permissible to have two conditions in one transaction. And no profit is permissible unless possession has been taken of the goods. And you cannot sell what is not in your possession."
In another hadith, the Prophet, peace be upon him, forbade selling any item from the same place where it was bought; a buyer must first physically acquire these items (lit. " ... add them to his own luggage ... ") then he may sell these goods. [Narrated by Ahmad and Abu Dawud; classed as sahih by Ibn Hibban and others]
The point of this rule is that whenever an investment contract is structured such that one party is guaranteed a profit, something is simply not right. Only in a pure riba transaction will there be guaranteed profit. Any permissible transaction in the shari'ah must have an element of risk involved, no matter how small that element is.
Therefore, when looking at this particular transaction, it is essential that the bank (the stronger party) not take advantage of the client (the weaker party) by exploiting the financial power of the former and the desperate need of the latter. If these banks enact their transactions with this principle as an underlying morale framework, I think such contracts that we now see will disappear. Yet, the reality is far from this ideal. In light of this principle, we should always ask the following question: Do these banks share with their clients the risk of loss, or are they are stipulating all possible conditions to protect themselves against any foreseeable loss? Additionally, do these so-called Islamic banks own the properties they are renting to people?
If we give sincere answers to the questions in discussion, we will see that the current ijara schemes are almost identical to conventional mortgages. They appear to be a ruse designed to promote conventional interest-based practices using Islamic terminologies and shari'ah expressions.
Based on this, the ijara scheme as it is implemented here in the UK by major banks: Ahli United Bank (formerly called the United Bank of Kuwait), United National Bank and HSBC is totally prohibited. In fact, it is a deception rooted in riba. Until the Muslims in charge of these schemes prove that the above argument is invalid and give clear answers to the questions highlighted earlier, I believe that such transactions are totally prohibited, and I warn brothers and sisters not to get involved with them. I would also like to emphasize that the view of some Muslims, that this scheme is better than the conventional riba based mortgage alternative and should therefore be used until a pure halal scheme is available, is incorrect. This is because there is no significant difference between the two schemes.
And Allah knows best.