Why Islamic Mortgages Are More Expensive

As many of my friends may know, I have done a lot of digging (and writing) on Islamic mortgage options available to potential homebuyers who want to avoid interest. At one time, it could be said that most are scams, but that is no longer true. There are some options available nowadays, but of course there are big problems with all of them. Not all are 100% Islamic (sadly), but some are better than others.

I am writing this post to explain why when you go to an "Islamic" mortgage, you actually end up paying more. There are two main reasons for this.

Reason one: the Islamic "bank" is actually borrowing the money themselves from a credit union or a bank. This is far more common than you think, and of course the "Islamic bank" has to really pay interest on that loan. They in turn collect that from you the home buyer, but call it profit margin. And since it's usually 0.5% more than the interest rate they themselves pay, it's really profit for the Islamic bank also.

Essentially they are the middleman and you are paying them. So you have to ask yourself, how Islamic is all this really? You are not paying interest, the "Islamic bank" is neither collecting nor paying interest (allegedly), but somehow that underlying credit union or bank is still getting interest. Who is fooling who?

Reason two: The Islamic bank has rich investors (usually from abroad like Malaysia, Kuwait or Saudi Arabia), and has to offer them better investment rates than the bank bonds. 

So for example you can right now buy a Gov of Canada GIC bond and get rate of 5%. It's risk free and in 5 years you get your principal back as well. So why would these investors not buy a bond, but loan to a poor Muslim such as you or me to buy a home? So they get a better return than the bond, of course. 

And since you cannot make money off a loan, this whole house transaction is structured as a business partnership (shares in the house and all that). Ultimately you end up paying a profit margin of around 7-8% because these investors want to beat the bond market. 

It would be simple if the Islamic bank just bought and sold the house to you, right?  Take this example: say this investor buys a house at $500 K and sells to a Muslim family at 650K the day later. Guaranteed profit, but of course the average family will take years to pay back. Say 10 years for our example. 

The rate of return is actually 30%. But over the 10 years it's less than 3% rate of return. The investor will say, I will just buy the bond.

Hence the Islamic bank will have to entice them with a better rate. No one will buy a $500K house for $1 million, so they have to do all that shares business nonsense to structure it in a "halal" way.

In the end, none of these loans are truly 100% halal - some are just more Islamic than others. Remember, all of them renegotiate the loan very 5 years ... this is a big problem from an Islamic fiqh point of view. The problem is that they are trying to square a round hole - make money off a loan.