By Kimmo Z. Hussain
Muslim Americans and Muslim immigrants of all nationalities and from all regions of the globe have an ever increasing presence in, and represent a growing percentage of the population of, New Jersey. Areas with considerable concentrations of Muslims in New Jersey include the cities of Jersey City and Paterson and the greater Newark area.
A common desire of New Jersey Muslims, not dissimilar from the aspiration of most New Jersey residents, is to own a home. Unfortunately, accomplishing this goal is often difficult, if not impossible, for adherents of the Islamic faith because of practicing Muslims’ unwillingness to make use of conventional financial products. This hesitation arises from Islam’s prohibition on the charge and payment of interest – Riba – which permeates conventional finance and banking. Islam also requires equity participation by the lender and the borrower.
An Islamic Mortgage
The essential elements for an Islamic mortgage include: equity participation by the lender and the borrower; risk allocation; and profit-loss sharing arrangements to all parties to the transaction. Islamic financial products must also adhere to certain fundamental principles, including the avoidance of interest or unlawful gain – Riba. Finally, a board of Islamic scholars, a Shari’a Board, must be assembled to oversee the program.
Generally, if a lender acts as a third party in financing a borrower’s purchase of an asset from a seller, the action is deemed unacceptable under Islamic Law unless the lender directly purchases the asset and owns it outright prior to the transfer to the ultimate borrower.
Under the classical Murabaha – “cost plus” – financing, the Islamic bank purchases goods from a third-party vendor, on behalf of the consumer and according to the consumer’s specifications, and then resells the goods with the transfer of title to the consumer at a predetermined markup of the purchase cost on a “cost-plus” basis. The lender constructively takes possession of the goods and assumes the risk of loss for the item for only a brief period of time. After the lender takes possession of the goods, the goods are quickly transferred to the consumer. The consumer repays the principal and the bank’s profit in installments over an agreed period of time
New Jersey’s common law of mortgages may provide the groundwork for an Islamic financial mortgage product that is both permissible under New Jersey’s banking laws and sensitive to Islamic legal principles.
Under New Jersey law, a mortgage lender receives an immediate interest in the real property, subject to the borrower’s right of possession (Boteler v. LeBer, N.J., 1993). The lender’s interest in the property is extinguished by full payment of the mortgage debt by the borrower. Before full payment, the borrower has an exclusive right to possess the property as long as there is no default in the mortgage obligations (Cohn v. Plass, N.J., 1915). Upon default, the lender is entitled to possession of the mortgaged premises, which he may acquire by taking possession of the premises peaceably or publicly. The lender also may take possession of the premises by instituting an action for possession of the land (Feldman v. Urban Commercial Inc., N.J., 1960).
The proposed approach in structuring a mortgage product based on the unique characteristics of a mortgage in New Jersey – the proposed mortgage – involves a transaction almost identical to a conventional mortgage transaction. The main difference with the proposed mortgage and a conventional mortgage will be that all provisions for the payment of interest on the borrowed funds will be altered to reflect a “profit amount” under the proposed mortgage. As with interest in the conventional context, the profit amount will be realized by the lender over the course of the loan term.
Another difference with the proposed mortgage shall occur in the event of default by the borrower for non-payment of monthly installment(s). The lender in a conventional mortgage is permitted to charge interest on the outstanding balance. Under the proposed mortgage, the lender is permitted to charge a default penalty to cover its fees associated with the borrower’s default and to penalize the borrower for non-payment. However, any amount received by the lender in excess of its expenses must be donated to charity.
The program will be designed in the following fashion:
1. Borrower will enter into a contract to buy a home located in New Jersey from a seller at an agreed upon price;
2. Borrower applies to the lender for financing and the lender processes the borrower’s application in accordance with its usual underwriting practices for home mortgages;
3. If the lender approves the application, it will issue a commitment letter to the borrower specifying the terms of the financing; and
4. At a single closing:
a. The lender makes payments to the seller of the balance of the purchase price under the contract, which represents the difference between the purchase price and any earnest money deposit;
b. The seller executes a deed in favor of the borrower and delivers it to borrower.
c. The borrower executes a note evidencing the debt to the lender; and
d. The borrower executes and delivers a mortgage to the lender, simultaneously creating an estate in fee subject to defeasance and securing the borrower’s payment obligations under the note.
The proposed mortgage is very similar to conventional financing: It is based on the unique characteristic of a mortgage in New Jersey where the lender, upon accepting a mortgage on the property, obtains an ownership interest in the property.
One challenge with the new approach from an Islamic perspective is determining whether the lender actually “purchases” the real property and owns it outright. In support of the approach, it can be argued that it is the lender’s funds that are used either exclusively or to a substantial degree for the purchase of the property. The lender also has a fee interest in the property, which fully vests in the lender upon non-payment of the mortgage installments by the borrower. Nevertheless, the effectiveness of this approach must be approved by a Shari’a Board.
A second challenge from an Islamic perspective is determining whether a joint venture exists involving the lender and the borrower. In support of the joint venture, one can argue that the joint venture exists as all parties bear risks and rewards in the transaction. The lender makes a profit as determined from the profit portion of the monthly installment amount and the borrower makes a profit on the potential long-term capital appreciation of the property.
Risk allocation, as required by the Shari’a, is also shared between the lender and the borrower in the proposed mortgage. The lender bears the risk of the mortgagor’s default on the note and the casualty risks to the property are shared jointly by the participants in their respective equity interests in the property. Nevertheless, the casualty risks are minimized by the borrower’s purchase of insurance (preferably mutual insurance) on the property. Approval of a Shari’a board will be required as to the effectiveness of the program.
An Effective Solution
It appears that the proposed mortgage based on New Jersey’s common law of mortgages may be an effective means of creating an Islamic finance mortgage in New Jersey. The basic Shari’a elements, including the prohibition of interest, equity participation, a joint venture and risk allocation, are present. Of course, a Shari’a Board may require additional elements, which must be incorporated into the proposed mortgage.
Kimmo Z. Hussain is an associate attorney with Riker Danzig Scherer Hyland Perretti LLP. He is experienced in structuring real estate investment and financing and project financing based on Shari’a principles. Hussain may be reached at (973) 538-0800 or firstname.lastname@example.org. Disclaimer: Nothing in this article should be relied upon as legal advice in any particular matter.