Trying to compare Islamic interest free mortgages to seller financing is like comparing apples to oranges. They both are allowable in Islam, if the seller financing has no interest involved. Both seller financing and Islamic mortgage documentation must use the word profit rate or something similar and not the word interest.
Muslims everywhere are becoming inundated with banks and finance companies wanting to get their business. Muslims can only purchase a home with no interest except by hardship. This hardship could entail living in a bad neighborhood, not being able to rent, rentals being more expensive than homes and similar excuses. This law for Muslims to purchase a home with interest is called "The Law of Necessity."
As the conventional banking system realized the potential of offering Islamic mortgages, more and more ran to open a Sharia branch in their bank claiming that they now had Islamic mortgages available. A true Islamic mortgage is done through a financial business that does not deal with any form of riba (usury) at all. These banks who offer Islamic mortgages are not Islamic, but simply a no interest loan following the Sharia guidelines. The problem in America is that there are very few Islamic banks available.
Islamic Interest Free Mortgages Explained
An Islamic mortgage is usually done two ways. The first way is called "Murahaba" which means the bank buys the house that you want and then resells the home back to you at a profit to the bank. The profit rate is similar in most cases to the current interest rate being offered on conventional mortgages. Some banks and finance companies have taken advantage of this new founded "Gold Mine" and have raised the rates of the profit being charged on these loans.
The second type of mortgage being offered is the "Ijara." In this situation, the bank buys the home and rents the home to the borrower on a declining rent basis. This means that the rent is adjusted according to how much is owed on the home. At first the mortgage is high and so is the rent. As the rent is paid down, so does the rent decline. In this mortgage, no credit is given for the interest towards income taxes as the borrower does not own the home, merely renting.
The disadvantages of this mortgage are of course a chance for being charged too much for the mortgage due to bank greed. A smart borrower should shop around and compare conventional rates before agreeing to purchase a home through any financial organization. A simple mortgage calculator will tell the borrower if the loan is too high.
The down payment runs from 5% with PMI (Private Mortgage Insurance) to 35%. Make sure if you are placing less than 20% down on your home that the PMI is associated with the takaful method or Islamic Insurance Method. Application fees vary and so does closing costs. Paperwork required on Islamic loans is similar to applying for a regular mortgage.
Seller Finance Mortgages Explained
A seller financed mortgage is less expensive than an Islamic mortgage because there is no application fee and usually has very little closing costs involved. In this type of mortgage the seller is the bank and the escrow company may set up a savings or no interest bearing checking account for all money to be deposited into.
In some cases a wrap-around mortgage is used. This is where the seller has a mortgage and that mortgage is less than what the property is worth. So if the property sells for $200,000 and the seller has a mortgage of $100.000, the $100,000 is wrapped with the mortgage. The seller opens up an escrow and declares the total amount needed monthly which has been amortized over the agreed upon period. The escrow papers do not mention the word interest anywhere.
The borrower simply pays the escrow agent or bank each month the amount due and owns the home.
With the age of loans that are harder to get, more and more sellers are handling the financing for borrowers. The seller should have credit reports run, but credit is usually not a major factor in seller financed mortgages. The borrower has full rights to the property and should the borrower miss a payment, he may be evicted as in a normal bank loan.
The disadvantage of this type of financing is a clause called "Alienation or Due on Sale Clause." Most new mortgages have this clause and should the bank find out that the loan has transferred, the bank may call the loan due. The best scenario for seller financing is where the home is owned free and clear by the seller.
Islamic Preference on Mortgage Types
According to Islam both mortgage is acceptable and the mortgage with no interest is the best. A Muslim using the "Law of Necessity" as reason to purchase a home may use seller financing that has interest involved also. Keep in mind that a non-Muslim may purchase a home using an Islamic mortgage or seller financing. In most cases both the seller financed mortgage and the Islamic mortgage has a higher rate or interest than most conventional loans.
When choosing the right mortgage for you make sure there is no pre-payment penalty in case you have enough money to pay the loan off early. Even a seller financed mortgage may be refinanced with the proper paperwork submitted.
Resource
Financial Web, "Seller Financing"
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