Islamic finance

During the first decade of the 21st Century there was guarded interest in Islamic financial products such as Shariah-compliant mutual fund and loans.  This was in part driven by the novelty of such products, and, in part, by the different arrangements underpinning such products when compared to the traditional choices.  (As you might imagine, “Shariah-compliant mutual-funds” makes for catchy news headlines.)

The defining attribute of a Shariah-complaint mortgage is the absence of interest in the arrangement since, in Islam, dealing with interest is forbidden in the strictest terms.  This of course puts loan providers in a very precarious situation and thus requires a bit of ingenuity so that the lender can make the business relationship with the soon-to-be-homeowner worth their while.

Broadly speaking, an Islamic mortgage works by transferring equity to the buyer over a period of time.  This is accomplished as follows: the bank purchases the house on the buyer’s behalf (while charging the customary origination and various other fees) and agrees to a partnership with the buyer whereby the latter repays the amount in installments.  These installments include a fixed “premium” over the monthly equity repayments.  In effect, the lender buys the house and sells it back to the buyer and receives a monetary benefit precisely because it has greater access to capital.  In plain English, the lender is making money by having money.  Like the old saying goes: “If it looks like a duck and sounds like a duck—it’s a duck.”

If the Shariah-compliant mortgage proves anything, it is that creativity among the Islamic community is alive and well.  Though humorous, I do not mean to say that such arrangements are not without benefits.  (I am no expert on the Shariah-complaint mortgage or even the normal kind.)  I mean only to say that many non-Muslims sign up for these “mortgages” which leads us to conclude that there may be something worth learning from the way such loans are structured.  For some people, such an arrangement might make financial sense.  However, it seems to me counterproductive to add an extra variable (religion) to an already complex arrangement.

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