Tuesday, August 02, 2005

Is my conventional mortgage riba? -- A public challenge

At the last ISNA conference to which I was invited, I mentioned at a session on "Islamic home finance" that I have not seen a single convincing argument that my conventional mortgage is riba. I challenged those present to prove to me that my mortgage is riba, and promised to refinance with the institution of their choice if they can provide such a proof. Needless to say, I was not invited to any subsequent ISNA conferences, but that is not the problem. I have yet to receive a convincing argument.

Last Saturday, some friends and I stayed at the mosque after fajr, and I drew the following figures on the carpet to illustrate my confusion about the characterization of my mortgage as a ribawi loan. Now, I understand that the debt I owe my mortgagee is documented by a "loan", but so are "Islamic" mortgages (e.g. by HSBC, etc.).

Let me explain. My mortgage procedure went roughly as follows (with some simplification):

In words, this is what happened:

  • I brought a check for my downpayment payable to the title company.
  • The mortgagee wrote a check for the balance of the home price, which is equal to mortgage amount (again ignoring various legal fees, etc.).
  • Title company combined the two payments to pay the home seller (had the homeseller had a mortgage, it would have been paid off first, and the difference given to the seller, after fees, etc.)
  • Title company transferred propety title in my name, and gave mortgagee a lien on the property.
  • Simultaneously, I signed "mortgage loan" documents, documenting my debt to the bank for the balance of the home price (plus any closing fees) less my downpayment.
  • My loan document specified the amortization schedule, which I currently follow in making my monthly mortgage payments.

Notice that while the debt is documented as a "loan", there was never a money-for-money transaction between me and the mortgagee. In fact, I never received any money from the mortgagee. The only thing I received was the home title (and right to live in the home), and I paid a certain amount of money to the title company at closing, and then make periodic payments to the mortgagee. So, as far as I am concerned, my transaction has always been one of house-for-money.

Now, one interpretation of how jurists forbade this transaction may be their fixation on the "loan" characterization, which may have suggested a simplified transaction of the following form:

Under this imaginary scenario, I would have gotten the loan money, and combined it with my downpayment to pay for the house. Then, as I would have gotten the title, I would have given the mortgagee a lien on the property. There is actually a logistic problem here: I couldn't give the mortgagee a lien at the time I receive the money, since I would not yet have title at that time. Indeed, that problem is the one solved by the title company, acting as an agent to facilitate the simultaneous parts of the transaction (I pay, mortgagee pays, the seller collects, the seller gives up title, I get title, mortgagee gets lien and "loan" documents). In the process, it appears to me that the Title company has also avoided the riba charge of money now for money later dealings between me and the mortgagee!

Never mind those details, the solution proposed by Islamic financial institutions is for the bank (or a fully owned SPV thereof) to first gain title to the property, and then to either sell the property to me (murabaha model) or lease it (ijara or musharaka mutanaqisa models). The murabaha variation would look something like this (again in overly simplified form):


There are many reasons the latter structure is inefficient, and somewhat meaningless -- since "truth in lending" Reg. Z requires mortgagee to report the APR in this financing transaction, the "interest" component is usually deducted as mortgage interest on IRS filings (even though the IRS has not to-date ruled on whether such a price mark-up installments -- or rent payment in the lease model -- may be deducted as such).

But my purpose here is not necessarily to criticize the murabaha, ijara and other models used for "Islamic home financing" in the U.S., U.K., etc. My primary concern is to wonder: if the issue is simply to create a buffer so that I never have a money-for-money transaction, why isn't the agency of the Title Company (which I have argued to be required primarily for logistical reasons of simultaneity of multiple transactions) sufficient to break the charge of riba (money now for more money later).

So to summarize, we have a triangle transaction in reality:

  • Bank pays money now to home owner
  • Home owner gives me the house
  • I pay money later to bank

Some buffer mechanism is needed to avoid the bank giving me the money now, to be paid plus interest later. However,
that is already done through the intermediation of the Title company.

Why is this riba?

Please explain this to me.

20 Comments:

Anonymous Mohammad Fadel said...

From the perspective of a lawyer, the transaction you describe has two aspects: one contractual and one relating to property rights. Mortgages are interests in property, in this case, real property, and under the common law, title exists in two forms, legal and equitable. When a person purchases a home with borrowed funds, his obligation to repay that money is contractual, and is documented by convention in the common law as a loan. If he grants a mortgage to the lender as security for repayment, he is transferring legal title to that property to the lender, until such time as he "redeems" his title by paying off (typically) all amounts owed to his lender under the loan contract. The mortgagor retains what is called "equitable title", since he retains the right to use the property and the right to redeem the property on condition of repayment of the loan. As a purely formal matter, therefore, the payments are not in respect of the mortgage, but rather in respect of the loan. Once the loan is repaid or otherwise discharge, the mortgage is "redeemed" and legal and equitable title are united in the owner (resident) of the house.

I would also not hang my hat on payments going through the title company, who is merely acting as an agent for the seller and the mortgee (if a mortgage exists on the property to be sold). Under American law, it is generally permissible to grant a mortgage on property to a mortgagee prior to the time that the mortgagor has an interest in that property, but the mortgage does not "attach" until the mortgagor obtains his interest in that property.

I think the important point is the substantive point, that one's payment to the bank is a result of its' willingness to act as a co-purchaser of the property, and the loan contract should be viewed simply as an installment sale contract. In fact, American law will treat an installment sale contract or rent to own contract of a home as a secured lending transaction, in order to provide the purchaser the equitable protections that attach to a borrower upon default, e.g., that the lender must resell using commercially reasonable methods, and if the sale generates a surplus, such surplus redounds to the benefit of the nominal purchaser. (Often, deferred sales contracts will provide that upon failure to pay installments will result in the purchaser losing its equity.)

More generally, one difference I have noticed between Islamic law and the common law with respect to property is that the common law envisions multiple interests in property less than that of full owner, e.g., the distinction between legal title and equitable title. Islamic law, to my knowledge, did not contemplate that in the pre-modern period, hence the rule that if a pledged asset returned to the possession of the pledgor, the pledge was terminated. This was a problem related to establishment of property rights and preventing "secret liens" that could defraud potential creditors who would assume that a debtor in possession of an asset actually owns it outright. This is solved in modern legal systems using a recording system, and charging creditors with constructive knowledge of filings.

The basic point is that the mortgagee has an interest in the land that is being purchased through payments over time. How that can be haram simply because the payments are called "principal and interest" rather than "rent" or "purchase price" makes no sense to me, and the claim that it does makes Islam and Muslims look foolish.

The problem becomes, however, why permit secured lending but not unsecured lending? If you permit the former but not the latter, you then invite artificial secured lending structures that only increase transaction costs without reducing the cost of the credit provided . . .

In my opinion, we might be better served thinking more deeply whether (i) the riba that is documented in the hadith is in the nature of a religious prohibition or rather a prudential one which may be subject to changes in time and place, or (ii) even assuming that the doctrines of riba set forth in the sunna are eternal rules, do they apply to fiat currency such as the dollar? A unit of fiat currency can be viewed as a pro rata claim on the assets of the issuing country, and to the extent that the issuing country's assets are predominantly non-ribawi, why should a claim on non-ribawi assets be treated as though it is a ribawi commodity for purposes of the hadiths in question?

12:36 PM  
Blogger Mahmoud El-Gamal said...

You raise a number of important issues, so I'll try to address them paragraph-by-paragraph:

* I guess I may have been loose using the term "mortgage payments", meaning "mortgage loan payments". I had an argument once with Abdulkader Thomas about whether or not I actually own the property, given that I do not have a "clean title". Your distinction between equitable title (which I hold) and legal title (held by mortgagee) is most illuminating, and supports my intuition. I should definitely read more law.

* Sure, the title company is merely acting as an agent, but that agency buffer may be all that you need. Remember, Justice Usmani and his disciples allow the eventual buyer himself to act as the bank's buying agent, buying the property on the bank's behalf, and thenas the bank's selling agent, selling the property to themselves... That agency, and the resulting difference in possession type (guaranty as owner, trust as agent) makes all the difference to those jurists... So, I am merely playing the game by their rules: you want one degree of separation, no matter how thin, and you already have one!

* Couldn't agree more on the substance-over-form argument... I am literally (well, metaphorically most of the time, but sometime literally) losing my voice over it.

* The idea that rahn (pledged security, pawned property) should remain with the creditor does exist in the classical jurisprudence sources. However, I do recall that for some jurists this rule only applied to moveable properties (manqul), not to real estate (`aqar), which they allowed to be in the debtor's possession (that is the basis for mortgage laws under the title "al-rahn al-`aqari" in countries like Egypt.

Of course, your point on information and legal technology allowing title searches that were not possible before is also very well taken. I have used similar arguments to suggest that jurists need a new theory for secured lending in light of those technologies (which may render something forbidden in classical times permissible, or vice versa).

* That form-based "Islamic finance" makes Islam and Muslims look foolish is a sad reality.

* I agree that one cannot make a general argument for forbidding all forms of unsecured lending, and we have seen the silly "sukuk" structures that do exactly what you described.

On the other hand, we need some constraints on abuse of unsecured lending practices, e.g. resulting in credit card abuse, which has got to be viewed as usurious. This goes to a deeper approach that suggests abandoning juristic rulings on contracts, in favor of more nuanced guidelines for their use. For instance, some jurists have forbidden futures contracts, ruling that they are speculative in nature and serve no real purpose!! That is of course ludicrous, but Muslims continue to follow the opinions of such jurists, encouraging all forms of Shari`a arbitrage to synthesize the forbidden transactions from allowed ones (with added transaction costs, and possible legal pitfalls).

* The biggest question of all: dealing with Canonical Texts. I am unqualified to do so, and fear that I may never be qualified to go straight to the objectives of Law (Maqasid al-Shari`a) and the Texts, bypassing all jurisprudence... Dr. Nejatullah Siddiqi has made a strong case that we need to do that, but the thought still terrifies me... Perhaps that is why I am going back to the likes of Muhammad `Abduh, `Abdul Razzaq Al-Sanhuri and `Abdul Wahhab Khallf, and keep looking for their contemporary counterparts.

7:17 PM  
Anonymous Lamaan said...

Riba is a simple concept. Does the contract allow your debt to be changed without your consent, thus making it more difficult for you to pay? If so it has riba in it. If not then it doesn't.

Everything else written on riba is just the hubris of people trying to accept everyone's understandings and misunderstandings of riba as reported in the hadith as true.

5:06 AM  
Blogger Mahmoud El-Gamal said...

It's not that simple. The rule of "give me more deferment, I pay you more" is the classical pre-Islamic riba mentioned in the Qur'an (by consensus of exegetes). That is done by mutual consent of debtor and creditor.

7:02 AM  
Blogger heraish said...

Perhaps that is why I am going back
to:
"Muhammad `Abduh, `Abdul Razzaq Al-Sanhuri and `Abdul Wahhab Khallf,"

This is a good approach as the traditionally trained jurist will be better able to relate to there approach, it is hoped at least. If no contemporary is available I suggest that you recruit a graduate of one of the Islamic Universities to do research under a contemporary academic such as yourself.

2:19 PM  
Anonymous Lamaan said...

It is actually that simple. Trade is trade and riba is something else. Allah has allowed one and forbidden the other.

Riba was the practice of claiming an increase of debt as compensation for late payment. This is not consensual it is an imposed penalty.

Your claim that consensual deferment for a fee is forbidden by a consensus of Qur'anic exegetes is wrong. The prohibition of consensual exchange of time for money is only inferred from one hadith which was not defining riba as such but was a sahaba contraditing someone else's misunderstanding of riba. It does not come from the Qur'an at all.

Rather than recognise these distinct concepts as various misunderstandings of riba (which they obviously are), they are each given a term. Time for money is called "riba al nasai" and the concept the sahaba (ibn Abbas) was correcting is called "riba al fadl". These two are collectively called "kinds of riba forbidden in the sunnah" and are distinguished from the penalty imposing concept of riba by labelling it "the riba of jahilliya" or "the riba forbidden in the Qur'an".

The claim of those demanding compensation for late payments i.e. the usurers is that a dinar today is worth more than a dinar tomorrow. We reject this. The confusion comes in people jumping to the conclusion that because we reject this claim of asserted time value that we are asserting that a dinar today is equal to a dinar tomorrow. This is not implied. The rejection only involves saying that time value is a subjective judgement made in every trade and not a matter for judges to measure or enforce.

4:56 PM  
Blogger Mahmoud El-Gamal said...

I appreciate your spirited and emphatic assertions. However, I do not know of any exegetes who disagree with the view that whether the creditor offered: "ataqdi am turbi" (will you pay, or will you increase the debt amount?), or whether the debtor offered: "amhelni 'azedk" (give me more time, I give you more money), the outcome is the same riba al-Jahiliyya.

What was labeled riba al-nasi'a is the case where an increase is stipulated at the inception of the contract, rather than at debt maturity. Riba al-fadl is the case where there is increase in hand-to-hand trading. Those two are derived from the Hadith of the six commodities, which speicifies that trading of same-genus must be hand-to-hand and in equal amount. Violation of the first condition is riba al-nasi'ah and violation of the second along is riba al-fadl.

As for the statement that "we reject" that a dinar today is worth more than a dinar tomorrow, I am not sure who are "we", and how you come to this conclusion. Al-Shafi`i speaks of other commodities, saying that one would clearly rather have them today rather than later, and that is how he justifies increasing the price on credit sales in Al-Umm -- a pure time value argument! (Note also that all monies in classical times were commodity monies, so a dinar is just a certain amount of gold -- minting only serving for certification of its weight).

7:12 PM  
Anonymous Lamaan said...

The question "will you pay, or will you increase the debt amount?" is a false dichotomy. If a person is in difficulty making the payment, then he must be given more time until it is easy for him to make the payment, as per the Qur'anic injunction.

Demanding one of the two options of the false dichotomy is to force people into paying an increased debt. This is not trade by mutual consent. It is forced increase of debt and therefore riba (i.e. riba jahilliya.)

If the person can pay but would prefer to pay later he can take out a new contract involving debts in the future in exchange for some kind of current asset which he can use to pay the due debt. This is no different to a renegotiation of the debt and equivalent to the offer "give me more time and I offer to pay you more". There is nothing wrong with this so long as the debtor knows he has the option to claim he is in difficulty and delay payment without financial cost.

The question that remains to be answered is what constitutes "difficulty"? Who can claim it? Does this indeed need definition, or should we rather allow anyone to claim it under any circumstances and merely let the market adjust by having effect on the debtor's credit rating / reputation?

Given the absence of any definition of "difficulty" in the Qur'an this seems to be the the right approach. So, given the choice "will you pay, or will you increase the debt amount" the answer could be, "Neither. I will pay as soon as it is easy for me to do so".

Once this option is made well known and available to people, then contracts which are essentially time for money will not be guarantees of profit. Rather, they will have instead have built in a great incentive to help the debtor become successful and become able to pay his debts easily. This is how Islamic finance, if done properly, avoids unjust exploitation and forces a large degree of equity and risk sharing.

6:05 AM  
Blogger Mahmoud El-Gamal said...

Lamaan: I apologize, I had misread your assertion regarding time value. I just re-read your statement and noticed that you were in fact asserting that there is time value. I still disagree with your assertion that it is subjective, however. After all, I am an economist. Moreover, the "benchmarking" to conventional interest rates (typically LIBOR)used by jurists in determining "profit" or "rent" in "Islamic finance" also suggests that they agree with the appropriate way to calculate time value in a given contract: a baseline riskless rate + appropriate credit or liquidity spreads.

2:56 PM  
Blogger heraish said...

The more Islamic mortgage.

What I would like to see is to make the current "ISlamic Mortgage" more consistent with the
spirit of Islam is that the mortgagor should partake in the case of loss.
This could happen in the case there is a depreciation of the property and the customer,
for whatever reason, is forced to sell and is not able to cover the loan amount he owes -
the mortgagor should partake in the loss and not hold the mortgagee responsible for the
total amount owed. Currently the mortgagee is responsible for the total amount owed due
to breach of contract. One of the Islamic "mortgages" I am familiar with does have a
non-recourse clause where the mortagor does not chase the other assets of the defaulter.

The defaulter however does get his credit score messed up.

Wallahu alem.

11:14 AM  
Blogger heraish said...

Bismillah Arrahman Arraheem,

In the "Islamic" mortgage we sell the customer writes a check including the closing costs, and downpayment directly to the title company and brings it to the closing table. We the mortgagor also "wire" the money to the title company.

10:35 AM  
Blogger Mahmoud El-Gamal said...

I assume you mean "we mortgagee ...". At any rate, that is how conventional closings are conducted as well.

12:27 PM  
Blogger heraish said...

Jazakallah kheir Professor, for the correction.Yes that is what I meant in my two previous postings.

"Motgagee" where "Mortgagor" is mentioned.

1:55 PM  
Anonymous Lamaan said...

Well, there are as many appropriate ways to calculate time value as there are people who value time. I pay my bank to keep my money safe until I want to use it. I don't want lots of cash lying around my house. In this case I value having my money tomorrow more than having it today. I don't claim that subjective judgements are not based on real physical economics. Rather, it is the case that if someone is in difficulty and cannot easily pay their debt, then punishing them by increasing the debt is wrong. This happens if you claim compensation for delays in payment. Such claims are based on the assertion that money today is objectively worth more than money tomorrow. This is what makes delays in payment equal to an injury deserving compensation.

Now, delays in payment may amount to injury if the debtor could easily pay but chooses not to. However, the debtor hurts his own reputation and will find it harder to get any credit in the future.

In such circumstances of unwarrented delays the party owed money may go to court to force payment, which could in principle have damages and costs added. This though is for a court to decide and not for unilateral imposition by one party to a contract.

This latter aspect is really the core of what riba is about. It is about putting into a contract mechanisms of contract enforcement in which the party owed something can pick the punishment of the debtor who delays payment. This places the lender in the position of a master and the debtor in the position of a slave and subverts the law, which itself becomes a slave to the lender and is obliged to carry out the lenders chosen punishment.

Allowed to go to its logical limits, governments that allow riba become the debt slaves of lenders.

3:29 PM  
Blogger Ali Yasin said...

Sir,
Is the crux of your argument that no money-for-money transaction took place and that a money-for-goods transaction involving interest is not riba? If so, are credit card transactions where you buy actual goods, a "loan" for particular goods, not riba either? Any guidance on your argument would be much appreciated, I am a novice trying to navigate my way through Islamic finance.
Regards,
Ali

10:20 AM  
Blogger Muhammad Saeed Babar said...

One who buys house on mortgage obviously does not have sufficient money to out right buy the house, can we term this attitude "living beyond one's means?" If so then

"And follow not the bidding of those who are extravagant" Aya 151 Sura Ash-Shua'raa

Narrated Warrad


(The clerk of Al-Mughira) Muawiya wrote to Al-Mughira: "Write to me what you have heard from Allah's Apostle." So he (Al-Mughira)
wrote to him: Allah's Prophet used to say at the end of each prayer: "La ilaha illalla-h wahdahu la sharika lahu, lahul Mulku, wa lahul Hamdu wa hula ala kulli shai'in qadir. 'Allahumma la mani' a lima a'taita, wala mu'tiya lima mana'ta, wala yanfa'u dhuljadd
minkal-jadd." He also wrote to him that the Prophet used to forbid (1) Qil and Qal (idle useless talk or that you talk too much about
others), (2) Asking too many questions (in disputed religious matters); (3) And wasting one's wealth by extravagance; (4) and
to be undutiful to one's mother (5) and to bury the daughters alive (6) and to prevent your favors (benevolence) to others (i.e. not to pay the rights of others) (7) And asking others for something (except when it is unavoidable). Sahih Al-Bukhari 9:395

Narrated Aisha


(the wife of the Prophet) Allah's Apostle used to invoke Allah in the prayer saying "Allahumma inni a'udhu bika min adhabil-qabri, wa
a'udhu bika min fitnatil-masihid-dajjal, wa a'udhu bika min fitnatil-mahya wa fitnatil-mamati. Allahumma inni a'udhu bika minal-ma thami wal-maghrami. (O Allah, I seek refuge with You from the punishment of the grave and from the afflictions of Masiah Ad-Dajjal and from the afflictions of life and death. O Allah, I seek refuge with You from the sins and from being in debt)." Somebody said to him, "Why do you so frequently seek refuge with Allah from being in debt?" The Prophet replied, "A person in debt tells lies whenever he speaks, and breaks promises whenever he makes (them)." 'Aisha also narrated: I heard Allah's Apostle in his prayer seeking refuge with Allah from the afflictions of Ad-Dajjal. Sahih Al-Bukhari 1:795

"If the debtor is in a difficulty grant him time till it is easy for him to repay. But if ye remit if by way of charity that is best for
you if ye only knew." Aya 280 Sura Al-Baqara

What if the debtor is unable to pay his debt due to any reason? And what if the creditor is not willing to extend time till it is easy for the debtor to pay?

Then the Hadith narrated by Hazrat Aisha(RAA)would be a fitting case and Allah's wrath would be up on him because of lies and breaking of promises. What would be the fate of Muslims? The answer is very obvious.

6:56 AM  
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8:22 PM  
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2:48 AM  
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11:52 PM  

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