The issue is NOT that Riba is difficult to understand. The main issue is IF people want to understand it to start off with.
Here is the Qur’anic “anchor” verse which defines Riba.
2:279 …ye shall have your capital sums: Deal not unjustly, and ye shall not be dealt with unjustly.
There are three requirements which need to be satisfied:
1. Return of the “capital sum.” Note: 2:278 has already negated the excess over the “capital sum” regardless of the magnitude of that amount. This negates the discussion related to usury vs. interest and Al-Jassas vs. whatever else.
2. No injustice to borrower.
3. No injustice to lender. This also ensures that lender’s capital sum is protected through the injunctions of verse 2:188.
If the transaction was done through paper currency and the inflation fraud did occur during the time period when the lender was out of his capital sum, the “la tuthlamoona” requirement of verse 2:279 will guarantee that the lender will be made whole.
I have written in detail about these issues on my November 19, 24 and 25 blog entries.
Verse 2:278 nullifies all the wrongly written contracts when the lender stipulated the gain; regardless of how usury vs. interest vs. simple interest vs. compound interest is defined. However, in the characteristic style of the Qur’an, verse 2:279 allows lenders to get their “ruoosu amwalikum” or “principle sums” and assures them that if they didn’t act unjustly they would not be dealt with unjustly.
Having dealt with existing problem contract situations, verse 2:282 defines the Islamic scheme of contract writing for future obligations.
“Let him who incurs the liability dictate, but let him fear His Lord Allah, and not diminish aught of what he owes.” 2:282
If the lender lends $100 for someone to buy medicine for his sick son, the borrower would most likely write; “I owe $100 payable on such and such date.” Commonsense suggests that if the borrower wrote anything above $100, it would be because of the implicit manipulation of the lender.
However, if the borrower is going to use those $100 to make $1,000, he could very well write $300 as “what he owes.” Verse 2:282 actually advises the borrower to be detailed in writing down his obligation
Now what happens if the guy who borrowed for medicine does not have money to repay?
Verse 2:280 stipulates that the borrower will be allowed extra time. The verse also encourages forgiving of the loan even though it does not stipulate it.
What about the guy who borrowed $100 to make $1,000 but for some reason did not make that $1,000? If he and his scribes were careful as instructed in 2:282, then they would have accounted for such contingency, and would have written the language carefully. Let’s say that he only made $500. He can technically say that he does not owe anything since he did not make $1,000.
This is where 2:188 kicks in, in conjunction with 2:279:
Verse 2:188 demands, “Do not devour the wealth and property of others unjustly, nor bribe the officials or the judges to deprive others of their possessions.”
And 2:279 promises the lender, “ye shall have your capital sums: Deal not unjustly, and ye shall not be dealt with unjustly.”
The judges will dictate what will constitute “ruoosu amwalikum” or “principle sums.” The borrower as well as lender is warned against bribing the officials and judges.
Note: This is not a religious argument. It uses religious language to produce a consumer rights argument in favor of developing genuine Islamic Finance products.
The real Islamic Finance (IF) operates with boundary conditions which are not even discussed among the Islamic “Loophole” Finance (ILF) circles.
Some of the boundary conditions are:
- Muslims must not accumulate beyond their needs. (2:219). The counter-logic given by the ILF circles is that if one does accumulate how will he give Zakah. The answer is that if one does not accumulate then that money would not disappear in thin air. It would be circulating in the system. Therefore, one billion people giving $1 Zakah is better than one person giving $1 billion Zakah. If one billion people gave $1 Zakah, it means that they each possess at least 85 grams of gold and are all net asset positive.
- Hoarding is prohibited. This is somewhat related to the above boundary condition.
- There is no time value of money. The absence of time value of money forces the holders of money to make decisions based on factors other than risk-less optimization of the same. Since money cannot be accumulated, it can only be lent without interest or invested to create value. Modern Portfolio Theory has no place in the real Islamic Finance.
- Monetary risk must be assumed by the owner of capital. The owner of capital cannot shift risk of loss by either contract mechanics or by purchasing protection against loss. Mutual risk-sharing is allowed.
- Poor, needy, people friendly towards Islam, captives, debtors must be monetarily assisted.
- God prevents parents from killing their offsprings due to the fear of hunger. He then promises that He will feed both parents and children. In the absence of an economic system which feeds all, parents are forced to kill themselves and their children.
If Muslims didn’t have money, then they would be excused. But if they do have money and they don’t create a system which feeds each and every human being, then it means one of two things: The Qur’an lies or God must perform miracles to make sure that every one of the human beings is fed.
It is Muslims’ responsibility to create economic systems so that on one hand people have decreasing levels of debt, and on the other hand those currently living under $2/day have a way to have $4/day then $8/day, then $16/day and so on.
By wasting their time creating “silly models” (as per Prof. El-Gamal) of Islamic “Loophole” Finance, are Muslims challenging God to perform miracles the same way Moses’ people challenged him to conquer the city by himself with his God (5:26)?
I have been told many time by IF practitioners to not use “interest free” in my communication. The reason given is that “investors will not come to you.”
I have also been told not to criticize IF and conventional finance for the reasons of “dawah.”
Past three days were very eventful…
I was in discussion sessions on Monday and Tuesday where Muslim and non-Muslim practitioners and curious people were in attendance.
I kept identifying the holes in “Shariah Compliance” of various instruments and the facilitator of the discussion kept reverting back that “this is what the scholars have approved.”
After one of the sessions, one person came up to me and told me that he was not a Muslim but was fasting for the past three years and was very close to becoming a Muslim. Now here is the kicker…
His original reason for getting attracted to Islam was the humane and ethical nature of Islamic finance. However, the discussion confused him and he did not believe that what was being practiced was either ethical or humane.
He told me that he specifically appreciated my presence in the sessions.
Also, I was in attendance at El-Gamal’s presentation at Harvard today. After the presentation one lady came up to me and introduced her as one of the higher officials at one of South Korea’s regulatory bodies. She told me that she never heard of the point of view El-Gamal brought to the table. She informed me that Korea is looking at Islamic finance as a diversification strategy from the conventional finance.
What is being practiced today as “Islamic Finance” is enough to discredit the industry in the short run and Islam in the long-run.
According to this website, which happens to sell gold, the metal has ZERO inflation. http://www.publicdinar.com/
So inflation has not been one of the considerations in the prohibition or permission of riba (regardless of how it is defined.)
It is the frame of mind which needs to change. On one hand you have JAK Bank of Sweden whose 35,000 members have determined that they are willing to take the inflation hit in order to promote their interest-free banking model.
On the other hand you have “Islamic” finance interestingly promoted by structured finance people with the help of lawyers, auditors and regulators. Their frame of mind is that investors are entitled to certain return on their investment.
The second group tends to gloss over one of the key Islamic ethos that excess funds in anyone’s possessions are to be used for the welfare of the humanity. This is a very comprehensive compilation of all relevant verses http://www.alhudapk.com/reading-material/articles/An-Investment.pdf (Note: You may or may not agree with the conclusions drawn by the author, but use the document as a reference for the verses involved in the author’s argument.)
What is being passed on as “Islamic Finance” is nothing but “Shariah Tolerant” components of the conventional finance. And more power to those who want to participate in conventional finance in a “Shariah Tolerant” way. More power to them.
However, if the concept of allocating excess funds for the welfare of the neighbors, community and humanity in general is missing, then stop labeling a limited commercial enterprise as “Islamic Finance.”
The reason is that calling the current hodgepodge of financial products as “Islamic Finance” delays the development of real Islamic finance for those who are interested in the real thing; which happen to be Muslims as well as non-Muslims.
If you look at page 12 of this paper http://issuu.com/margritkennedy/docs/pre_moneypres , you will see that in the current banking system, interest has four components:
1. Fees for the work of the bank (usually around 1.7%),
2. A risk premium (around 0.8%),
3. A liquidity premium (around 4%) and
4. An inflationary adjustment (around 1.5%).
The fee to operate a bank cannot be eliminated, unless the costs are absorbed by the taxpayer but the costs remain nonetheless.
The risk premium can be eliminated by instituting a takaful setup.
The liquidity premium should be non-existent in an Islamic environment.
The inflationary adjustment will be with us until the riba-based currencies are in existence.
JAK Bank’s ( http://www.jak.se ) depositors have decided to give up #3. Also, they are willing to take a hit on #4 as a cost of promoting their belief in interest-free human existence. THAT is the cost Muslims WILL HAVE to bear until they are able to figure out how to eliminate inflation. If Swedes can do it, so can Muslims.
Muslims who are at war with Allah and His Prophet as per verse 2:279 and are busy trying to argue that “Trade is like Riba” as warned in 2:275 (and it is the intent that counts) can learn from these 35,000 (primarily) non-Muslim members of JAK Bank of Sweden who are NOT making any excuses.
The borrowers are paying #1. As far as #2, they are participating in a “Self-Liquidating Takaful” (SLT). JAK’s model calls for creating takaful of around 17 people which are insuring each other. When the borrowers successfully pays her loan back she gets her full premium back.
Note 1: JAK does not call it Self-Liquidating Takaful. I coined the term. JAK calls it Loan Equity Deposit.
Note 2: JAK Bank is a $144 million bank. It is not a mega bank but it is not that small to ignore either.
Note 3: At this time I have no interest in “dawah”. My interest is in developing genuine Islamic Finance products.
Sustainable finance practitioners can find takaful to be a great enabler.
Takaful in Lending:
Take an example of the JAK Bank of Sweden. It borrowers money without any cost (depositors don’t get any interest) and lends money by charging a fee currently equivalent to 1.3% per year of the initial loan amount to cover its operational costs.
It also charges at the inception of the loan what it calls “Loan Equity Deposit” (LED) which is equivalent to 6% of the initial loan amount, and is used as risk insurance. This amount is returned to the borrower after successful payment of the loan.
LED could be thought of as “Self Liquidating Takaful.”
Takaful in Mudarabah (Startup funding):
Another application of takaful could be the guarantee against “specific performance” loss. For example, halal business entrepreneurs in New York can create a takaful before pitching murabahah arrangements with rabb al maal.
If 100 entrepreneurs create a takaful worth $100,000. This will require each participating entrepreneur to initially contribute $1,000 toward the takaful. They will pay, say, $25-$100/month to continue to increase the total takaful amount to provide additional mudarabah arrangements.
This group of entrepreneurs will then pitch their ideas to appropriate rabb al maal. Whoever gets funding first, gets to use the takaful guarantee. If there are more mudarabah deals than there is takaful money to satisfy rabb al maal’s guarantee, either the amount of each guarantee goes down, or all of the entrepreneurs contribute more money towards the takaful.
This amount will be used as guarantee to the rabb al maal that if he/she suffers a loss due to negligence of the entrepreneur then he will get certain amount of money from takaful. The flip side is that if the venture takes off, both mudarib and rabb al maal commit to contribute certain amount from their riches into takaful to engage more mudarabahs.
Since each entrepreneur has his/her money on the line, it would be better for him/her to form/join a group of entrepreneurs with caution. These entrepreneurs could also constitute a network of resources which could help the funded mudarabah succeed to get more money in takaful for future funding.
Every time the guarantee amount is released, entrepreneurs are given an opportunity to redeem their monies if they have lost interest in takaful or life has moved on for them. They may even make some money because one or more of the mudarabahs which got funded contributed significant amount of money into the takaful. They may lose money because one or more of the mudarabahs caused the takaful to pay out the guarantee amount to rabb al maal.
I can go on with other creative takaful arrangements to enable genuine Islamic finance, such as, student loans, seller financing, franchise financing, car financing, business financing, etc.
Truly Interest Free Student Loans
By Liaquat Ali
This article builds on the ideas discussed by this author elsewhere on the development of a non-profit organization, Interest Free Living (IFL), to proactively assist Muslims in putting their financial houses in order to pay Zakah as required by their faith. The article attempts to share specific ideas to help reduce consumer debt in relation to college education.
The most popular loan program in the United States called the Stafford Loan program raised its borrowing limit from $23,000 to $31,000 limit last year. Thus the US government essentially gave a green light to the colleges to increase their tuition up to 35% in the upcoming years. University of Phoenix, the largest private university in North America is not bashful to acknowledge that “it sets its tuition with the loan limits in mind.”
Families in America typically save for kids’ college through “529 Plans.” There are two basic types of 529 plans — prepaid tuition plans and savings plans. Prepaid tuition plans enable families to pay for future tuition now in current dollars and prices and are effective hedge against ever-increasing college tuition. The saving plans are nothing more than brokerage accounts where Wall Street related entities “manage” the money. Calling them “savings plans” is a misnomer. They are investment vehicles where up to 100% of the savings could be at risk. This author knows of a family whose “savings” dwindled down to 30% of the amount which was actually deposited by the family in a 529 Plan savings account.
The middle-class and lower middle-class people in the United States are the prime targets for consumer loans, including student loans. Riba or interest on those loans extends the duration of the loans and devours a significant portion of their hard-earned income for years, if not decades.
A seemingly valid argument is made by the beneficiaries of Riba is that capital has its cost. That is true in the non-Muslim context. The Qur’an requires Muslims to make their wealth available for common good. For example:
“They ask you how much they are to spend; Say: “What is beyond your needs.” (2:219)
“If you do it not, Take notice of war from Allah and His Apostle.” (2:279)
Therefore creating a Riba-free economic system is not a trivial matter for Muslims. This author believes that the amount of capital required to create such system will not cost anywhere near the excess wealth Muslims own; in the United States and around the world. It is a matter of rearranging how money flows through their lives. That’s all.
The college debt reduction and Riba elimination model, Riba Cleansing Therapy, developed by this author have three core components:
<!–[if !supportLists]–>1. <!–[endif]–>Freeze the tuition amount as early in a child’s life as possible.
<!–[if !supportLists]–>2. <!–[endif]–>Spread Riba-free tuition payment on three long periods, that is, several years prior to a child entering college, while attending college and, if needed, after finishing college.
<!–[if !supportLists]–>3. <!–[endif]–>Guide families to avoid money drain through Riba payments in other expenses in their lives.
The source of capital can be one or more of the following:
<!–[if !supportLists]–>a) <!–[endif]–>Cooperative: Development of family support groups whose college tuition needs are around 6 years apart. Grameen Bank’s bottom-up approach will be used to provide social collateral and mutual insurance through support groups whose members maintain prior relationships. Since people self-select group members who they already know and trust, the issue of adverse selection is avoided. Since default by one member will be considered default by all, the default risk is reduced, as proven by the Grameen Bank.
<!–[if !supportLists]–>b) <!–[endif]–>Fundraising: Fundraising from individuals and organizations that want to support specific educational institutions, provide perpetual scholarships or simply want to fund Riba-free student loans.
<!–[if !supportLists]–>c) <!–[endif]–>Interest Free Bank: Establishment of an interest-free bank similar to JAK Members Bank of Sweden. This bank can help support a wider range of Riba-free lending programs in addition to student loans.
The idea is to typically create support groups of four families which have a college bound student, an 11 year old student with 6 years in college, a 5 years old student with 12 years in college, and a newly wed couple. This author understands that requiring families to self-select group members may not always be possible. IFL will relax that requirement as higher donation levels allow for higher potential defaults.
The number of families in a group will depend on factors, such as, the number of students in a family who need to start college right away. For example, if two kids from a family need to start college right away, then they need to create a group of six families with appropriately aged children. These families will commit to living a Riba-free life, becoming Zakah givers or Muzakkis, and save for their children’s college education.
IFL will put these families on the Riba Cleansing Therapy, if needed. That is, IFL will look at their finances to see if it can advise them in eliminating Riba from their lives. Together, they may have certain amount of money which could be immediately used to purchase the tuition units for the first student or set of students. The elimination of Riba will allow them to save more for their children’s college education and also live a richer life.
IFL will lend the first family to make up the deficiency in the first student’s educational expenses. Like the Grameen Bank model, all families will be collectively responsible for any loan disbursed by IFL.
One of the common threads in philanthropic giving is donations to giver’s alma matter. Due to questionable prestige-seeking spending by universities in recent years, such as, the “Taj Mahal” recreation center at Ohio State University, $272,000/bed dorm at Princeton, 53-people Jacuzzi at Washington State University, etc., more and more donors are requiring universities to spend their donated money directly on students.
IFL will actively pursue philanthropic individuals and organizations to donate funds which will be leveraged by IFL to:
a) <!–[endif]–>Freeze tuition for the students,
<!–[if !supportLists]–>b) <!–[endif]–>Help students eliminate Riba from their families’ lives, and
<!–[if !supportLists]–>c) <!–[endif]–>Use the donation amounts again and again, as the money is repatriated, to direct students to universities of donors’ choice. In Islamic terminology it is called Sadaqah Jariah or perpetual charity.
Let’s see how a $100,000 donation representing four years of college expenses for a student works for a cooperating group of families.
1) <!–[endif]–>The philanthropist donates the money.
<!–[if !supportLists]–>2) <!–[endif]–>Four years of tuition units are immediately purchased for the first student. The rest of the money is set aside. For private universities and colleges, such as, MIT, Princeton, Stanford, etc., tuition units may be purchased through Independent 529 Plan. For state universities and colleges tuition units can be purchased through Guaranteed Education Tuition for Washington, Make College Possible for Pennsylvania, etc.
<!–[if !supportLists]–>3) <!–[endif]–>Four cooperating families start their Riba Cleansing Therapy with IFL. This may involve extending various small loans to these four families to get them out of Riba transactions. The students in college get the money from IFL as expenses are incurred. Expenses are scrutinized by IFL to make sure that students are not “living large” on their parents’ hard earned money. Thus inculcating prudent money management skills in their lives.
<!–[if !supportLists]–>4) <!–[endif]–>All families start making payments towards their own children’s college expenses along with the Riba-free payments for the other small short-term loans they may have taken out from IFL. IFL continues to purchase tuition units with certain percentage of the monies received.
<!–[if !supportLists]–>5) <!–[endif]–>IFL Continues to solicit donations from philanthropists so that it can lock as much tuition units as possible as early as possible. The locking of the tuition units will be one of the attractions to bring families to go through Riba Cleansing Therapy.
<!–[if !supportLists]–>6) <!–[endif]–>Due to the Riba-savings these families spendable income increases. This allows them to either purchase more college tuition units as early as possible or they can use the Riba savings to pay off the biggest Riba sink of all; their mortgage payments.
The success of cooperative and fundraising will lead IFL to either launch an interest free bank itself or to help develop one.
Let’s look at JAK Members Bank of Sweden where its 35,000 members deposit their savings. Some of the members know it fully well that they will never borrow from the bank. Why do they still deposit their money at JAK?
They do it because they are serious about creating an interest-free world. Here are excerpts from JAK’s website:
<!–[if !supportLists]–>· <!–[endif]–>“Our bank is a practical example of a just and fair economy and that another world is possible. JAK is different because it is interest-free.”
<!–[if !supportLists]–>· <!–[endif]–>“We regard receiving money in exchange for labor and for risk-taking as legitimate; however we do not consider it legitimate to earn money simply with money. In our opinion it is unethical to lend money against interest if there is neither risk nor labor involved.”
<!–[if !supportLists]–>· <!–[endif]–>“In an interest economy money is moved from those who have less to those who have more and thereby assets are concentrated in the hands of the few.”
JAK members save money and earn “savings points.” When they borrow money, they have negative savings points. As they make payments they redeem negative savings points until they are paid up. They also make payments towards what JAK calls “equity shares” which basically act as insurance against default.
The end-result of the above Riba-busting models is to produce more and more net asset positive Muslims to help them become Muzakkis to perform the third pillar of their faith; Zakah.
Liaquat Ali’s is the author of “Private Money: The #1 Solution to Eliminate Booms and Busts in Real Estate Forever!” Ali is currently pursuing an MBA in Management and Strategy from the Western Governors University and is the founder of TrulyInterestFree.com
Truly Interest Free Seller Financing: A Uniquely American Approach to Interest-Free Financing.
By Liaquat Ali
Due to the demographic realities of the Muslims population in relation to the general American population; how real estate is bought and sold in the United States; and how US tax code handles real estate capital gains, it is possible to conduct uniquely Amercan interest-free financing by convincing sellers to act as financiers.
The ideas discussed in this article could be used by individual Muslims as well as real estate agents and investors. The Shariah compliant finance houses can also expand their deal flow by acting as agents for sellers who are interested in seller financing their properties on interest-free basis.
Due to the absence of the need to bring cash to the closing table, these finance houses can process considerably more transactions than they are currently able to do. This, in turn, can lower their operating costs which could eventually mean lower transaction costs for their clients for all of their Shariah compliant products.
The general American population has certain demographics trends which favor seller financing. The primary factors are age; family size; and education and income levels of the Muslim population in relation to the general American population.
Americans are used to buying houses on installments. A typical American goes through a 30-year regimen of making mortgage payments before his house is paid off. Therefore, he is mentally prepared to entertain seller financing offers if they are presented in a convincing fashion and the owner falls in certain demographics which are more likely to entertain such proposals.
Capital gain taxes are due in the year when those gains are realized. Unless buyers are falling over each other to purchase a piece of property — which is not going to happen for the next few years — a cash sale fetches a lower price and an instant capital gain tax. A seller financing transaction typically fetches a higher sale price and deferred capital gain taxes. Due to extremely favorable capital gain tax benefits on owner-occupied houses, such capital gain deferment would most likely be relevant to non-owner-occupied properties.
Let’s look at the demographics in detail. American Muslim population would reach 16 million by 2014. This is according to the data compiled by Allied Media Corporation which provides ethnic market data and trend consulting to governmental and non-governmental organizations, such as, Census Bureau, Department of Justice, Treasury Department, Western Union, Prudential Financial, Emirates Airlines, United Nations, etc.
In 2007 when Muslim population was estimated to be around six to eight million, the disposable income of Muslim consumers was estimated by JW Thompson to be $170 billion. Therefore, conservatively speaking, that disposable income could easily be north of $340 billion in 2014. JW Thompson is the largest advertising agency in the United States.
According to Harry Dent of HS Dent Financial Advisors Network who has written several books on demographic impact on economy, Americans purchase their starter homes in their late 20s up through the age 33. As their kids are nearing or entering high schools, they purchase their trade-up or larger homes. This buying cycle peaks between the ages of 37 and 42. At around age 48 the vacation home buying cycle peaks, and then at around age 50 the overall spending cycle peaks for the heads of the families.
A survey done by Zogby International in 2000 puts a little over 52% of Muslims in the 30-49 age group, which according to Dent is the prime home buying age. Another study done by Zogby International in 2001 indicates that 62% of Muslims either had bachelors or advanced degrees. If you include those who have some college education, the number goes up to more than 81%.
Muslim population is younger than the general American population. According to JW Thompson, 67% of Muslims were 40 years or younger in 2007 compared to the general American population; 67% of which was older than 40 year. According to Pew Research’s 2007 study, only 13% of Muslims were in the 55+ age group compared to 30% for general American population.
The 2007 American Housing Survey conducted by the US Census Bureau estimated that out of the 128 million total housing stock, the number of owner-occupied dwellings to be slightly over 75 million, and the “free and clear” units to be around 25 million. In other words approximately thirty three percent (33%) of owner-occupied housing units did not have any mortgages.
The population of the United States was 302 million on July 1, 2007. Seventy five million owner-occupied houses translated into one owner-occupied house for every four Americans in 2007.
According to a Cornell University study, Muslim family size was 25% larger than the US average family size in 2002. Other more recent estimates indicate that the Muslim family size is as large as 40% compared to the US average. The home ownership number needs to be reduced by 25% to 40% for Muslims, that is, one owner-occupied house for every 5 – 5.6 Muslim. Therefore, 7 million Muslims could be the proud owners of 1.26 - 1.4 million owner-occupied housing units in 2007.
As the American Muslim population goes to 16 million, they will go from owning approximately 1.26 - 1.4 million owner-occupied homes in 2007 to approximately 2.72 million homes in 2014.
Now let’s look at the non-owner-occupied housing stock. In 2007, 302 million Americans owned 53 million non-owner-occupied housing units, such as, second homes, rental homes, vaction homes, etc. That is, one non-owner-occupied housing unit for every 5.8 Americans. Since Muslims, due to their younger age, are half as likely to own non-owner-occupied houses, it can be estimated that one non-owner-occupied unit existed for 11.6 Muslims. Therefore 7 million Muslims owned 603,448 non-owner-occupied housing units in 2007. No family size correction is applicable here because those units are more likely occupied by non-Muslims.
Giving a 5% increment to that non owner-occupied housing stock from 2007 to 2014, and using the project US population of 322 million in 2014, one non-owner-occupied housing unit will exist for every 5.79 Americans and for every 11.58 Muslim. With a population of 16 million, Muslims will own 1.38 million non-owner-occupied housing units in 2014.
Muslims will go from 1.87 - 2.0 million total housing units in 2007 to 4.1 million housing units in 2014. This may be why AIG has recently launched its home takaful product in the United States.
In 2007 5.65 million existing homes were sold in the United States for an average price of $219,000. The data is provided by National Association of REALTORS (NAR) which, with more than 1.1 million real estate salespeple and appraisers as its members, is the largest trade organization in North America and claims to be “the voice of real estate” in the United States.
For the sake of simplicity, let’s assume that 5.65 million Americans sold 5.65 million houses to 5.65 million other Americans. The total American population in July 2007 was 302 million. If the Muslim age demographics were the same as the general American population, then it could be estimated that out of 7 million Muslims, 130,960 bought a house, approximately the same number of Muslims sold a house. Since, as per JWT and other sources, the Muslim population is twice as likely to be under 40 years of age which is the prime buying age as per Dent, the number of owner-occupied home purchases by Muslims could be as high as 175,486 in 2007. Based on the data provided by the NAR, the number of existing homes sold in 2009 would be around 4.5 million. Keeping the annual number of existing home sales to an average of 5 million per year, Muslims would purchase around 330,000 houses in 2014.
The Shariah compliant finance houses are currently financing 3,000 – 4,000 houses per year. Even if they increase their capacity by 10 folds, they would only be helping Muslims buy 30,000 to 40,000 houses by 2014. This leaves a gap of approximately 300,000 houses in calendar year 2014 alone, and nearly a couple of million more between 2009 and 2014.
Based on the unsustainable inflation of housing prices in the past several years, this author believes that the overall pricing trend for real estate would be downward until the prices hit the 2000 price levels.
With the average house price of $181,000 in 2009 and the average housing price of $120,000 in 2000, $150,000 is estimated to be a fair number to use for average house price in the next few years. Based on the $219,000 average price in 2007 and the $150,000 estimated purchase price in 2014, the 2.1 million houses Muslims will buy between 2009 and 2014, will be priced at $387 billion. At an effective interest rate of 6%, Muslims would have to deal with $23.22 billion of riba each year on top of the riba being paid on the majority of the 2.0 million houses they owned as of 2007.
According to certain private Muslim population estimates, 63% of Muslims live in colder states which are more likely see the exodus of general American retiring population. This group of Americans is more likely to own free and clear housing units than the younger Americans.
Assuming that 5 million existing housing units continue to change hands each year, a turnover of 30 million units will take place in the next six years. Some of those units will change hands more than once. A concerted effort needs to be applied to convince the sellers in the specific age group and geography to sell their properties on zero percent seller finance basis; to Muslims as well as non-Muslims.
The benefits for the seller are: quick sale, high sale price, potential tax deferment benefits, and a monthly check. The benefits for the buyer are: quick purchase process, saving of most of the closing costs, quick payoff of equity, and a possibility of getting flexible payment terms. For Muslim buyers, the top reason is to meet one of their religious obligations of avoiding “war from Allah,” as per verse 2:279 of the Qur’an.
Assuming an annual interest rate of 6% and an average down-payment of 10%, the average Muslim buyer of a $198,000 house in January, 2008 would have financed $178,200. She would pay nearly $71,283 in interest and her principal owed would still be at around $159,737 at the end of 2014. Statistically speaking, it is more likely that she would have sold that house for a price hovering around $150,000 before 2014 without making much dent on the principal. Thus losing her 10% deposit in addition to all of the interest she paid. If she continued to own the house she would have to make monthly payments for the next 23 years to pay it off completely.
A similar $198,000 house purchased on seller financing with 10% down, 0% interest and 14 years payment plan, the principal owed would be $89,100 at the end of 2014 with only 7 more years to fully pay the house off. The monthly payment for a 14 years payment plan on 0% interest would be the same as the monthly payment based on 30 years amortization at 6% interest. The interest saved after the 14th year could be used to purchase another house; save for other major expenses; improve lifestyle; or to spend on community needs.
Due to the current credit freeze, the general sell orientation of 67% of the richest and the aging population, and soft economic forecasts by Dent and others, price appreciation should not be part of any real estate buying decisions. Therefore, the buyers need to be very clear that whatever kind of financing they take has to pay down the principal in the shortest period of time because that’s where the equity will come from, and not from price appreciation.
Those who don’t understand how to chart the murky waters of real estate valuations in the next few years are better off renting.
Muslims are half as likely to be in the age group which has the most “free and clear” homes. Therefore, the “free and clear” homes owned by Muslims would be around 16.5% as compared to 33% for the general population. Using such approximation would yield 330,000 houses to be owned by Muslims without any mortgages in 2007 and 676,500 houses in 2014. Since Muslims cannot continue to be on the receiving end of the development of interest-free finance space on the shoulders of non-Muslims, certain number of these Muslim owners needs to be persuaded to make their properties available on interest-free basis to Muslims as well as non-Muslims.
Non-profit downypayment assistance program will need to be established to cater to the situations where the seller is ready to seller-finance the sale on interest-free basis, but the buyer does not have the required downpayment. These loans need to be on “qard hasan” basis where the rules of Qur’anic verses 2:278 – 2:282 would apply. Zakah funds may be used as per one or more categories of the uses of Zakah in verse 9:60 of the Qur’an.
Liaquat Ali’s areas of expertise are real estate investments and “private money” which he has used for his real estate transactions during the past six years. To him riba-free transactions are simply a special case application of the private money space. The author defines private money as the source of funds where the owner invests directly. Intermediaries if any have low or no influence on the transactions. The second requirement for the private money is that the terms are flexible, individually negotiated among principals and are not dictated by institutional indexes or underwriting criteria. Ali is the author of “Private Money: The #1 Solution to Eliminate Booms and Busts in Real Estate Forever!” and is the founder of TrulyInterestFree.com
Expansion of Zakah Through Eradication of Riba and Reduction of Debt
By Liaquat Ali
Zakah is the third pillar of the Islamic faith. It is considered an Ibadah or an act of pure worship. The importance of giving Zakah is repeatedly emphasized in the Qur’an along with Salah. Generally speaking if a Muslim owns assets which are more than the market price of 85 grams of gold, then he or she meets the requirement of Nisab and can become a proud Muzakki or Zakah giver to specific categories of people identified in Surah At-Tauba of the Qur’an.
Countless organizations exist around the world to consume the Zakah monies but none exists to deliberately enhance the Muzakki base. The purpose of this article is to share specific ideas to expand the number of Muzakki Muslims in the United States by eliminating Riba and reducing debt in their lives. Let’s take a quick look at the eight specific categories of people identified in verse 9:60 of the Qur’an as the potential recipients of Zakah:
1. Fuqara — Poor
2. Masakin — Needy
3. Aamileen — Those employed to collect and disburse Zakah funds
4. Muallafatul Quloob — Those whose hearts are to be won
5. Riqaab — Captives
6. Gharimeen — Those in debt
7. Fi Sabeelillah — In the way of Allah
8. Ibnus-Sabeel — Wayfarer. Some people translate it as homeless
Gharimeen are understood to be “those who are over burdened with debts”, “in debt” and “debtors” by some of the most notable translators of the Qur’an, such as, Muhammad Asad, Yusuf Ali and Marmaduke Pickthall, respectively.
“Debt, like the devil, comes in many disguises accompanied by its terrible twin of interest,” says Toby Birch who wrote his book, “The Final Crash: Addictive Debt and the Deformation of the World Economy,” under the pseudonym Hugo Bouleau.
Gharimeen are a special segment of the population who may have jobs or businesses but due to debt their net asset value falls below the Nisab threshold and forces them to become potential Zakah recipients instead of Zakah givers or Muzakkis.
They are also the prime targets of the consumer lending outfits. They have enough income to qualify for consumer loans, but their income is not enough to get them out of those loans in a short period of time. Riba or interest on those loans extends the duration of the loans and devours a significant portion of their hard-earned income.
Compared to the other Zakah recipients, due to the nature of Gharimeen’s distress, they are more likely to become Muzakkis if they are coached and assisted properly.
It is easy to advise someone to just wait until they have the means to purchase. It is just not that practical in many circumstances. For example, if one needs a car to go to a better paying job instead of walking to a lower paying job, then it makes the economic sense to buy the car and subsidize the car payments through the higher income.
However, consumer finance is causing the Muzakki base among Muslims to shrink through the expansion of debt in the community. The challenge for Muslims is to make sure that the pool of Muzakkis is strong and expanding, instead of weak and contracting.
Chronologically, verse 30:39 of Surah Ar-Rum is the first instance where the word Riba is mentioned in the Qur’an. The Qur’an denounces Riba and immediately proposes Zakah as the antidote. Therefore, Zakah in a society has an inverse relationship with Riba. Expansion of one will have negative effect on the other.
Through this article this author makes an earnest request to esteemed scholars of Islam to guide Muslims in the effective use of Zakah to expand the Muzakki base among Muslims. Otherwise, relentless consumer finance – where Riba takes many different names as eloquently warned in verse 2:275 of Surah Al Baqarah – will continue to deplete the Muslim Zakah base.
A seemingly valid argument is made by the beneficiaries of Riba is that capital has its cost. That is true in the non-Muslim context. In the Muslim context, the capital collected as Zakah does not have a cost. Creative utilization of a small portion of the Zakah funds has the ability to create virtually unlimited pool of sustainable capital to be lent on Riba-free basis to Muslims today and to the future generations.
While the Riba-busting weapon Zakah is wasted, conventional consumer finance is invading Muslim communities through contract Shariafication. That is, Islamic Finance is evolving out of conventional finance through contract modifications instead of the Qur’anic approach of utilizing Zakah against Riba.
Since the consumer lending business “rewards” its predictable and profitable clients by increasing their credit limits and manipulative loan offers, the Gharimeen continue to incur more monetary liabilities until debt becomes a way of life. A Muslim in such economic condition is not a Muzakki anymore. He is a Gharim.
The consumer lending outfits calculate monthly payments in such a way that consumers consider them “affordable” and many of them continue to pay the minimum amounts which are primarily interest payments and barely make a dent on the principal owed. Many consumers don’t even know that their monthly payments are income streams which have lives of their own and their consumer lending contracts are bought and sold just like commodities.
Americans are paying one-third of their after tax incomes or almost half of their before tax incomes to a variety of masters who buy and sell fruits of their daily labor by getting hold of them at the hour of their need.
Providing Gharimeen with non-profit loans or Qard Hasan instead of “give it and forget it” money, along with financial planning guidance, can give them an honorable way to fulfill the third pillar of their faith.
As envisioned in verse 30:39, the Zakah fund keeps growing as new money is donated every year, and as the money is repatriated from the interest-free loans given to Gharimeen in the previous years. Verse 9:60 designates part of the Zakah funds for Zakah collectors and distributors. So there are no operating costs which need to be passed on to the borrowers.
According to calculations performed by this author on US Census Bureau’s 2007 American Housing Survey, Muslims would “own” as many as 4.1 million residential houses in 2014. In reality, majority of those “owners” are debt-ridden tenants of their mortgage companies. They are Gharimeen. Also, based on the data provided by Automotive News Data Center, Muslims purchased around 160,000 cars in 2008 which would almost double when Muslim population goes to 16 million in 2014. Most of those cars would be purchased on Riba basis.
The ideas discussed in this article are geared towards those Muslims who want to create “Interest Free Living” for themselves and their families, and become debt-free to engage in the Ibadah of Zakah which is equally emphasized by the Qur’an along with Salah.
Based on the above discussion, this author strongly believes that there is need for a non-profit organization which can create a brand around empowering Muslims eliminate Riba and reduce debt to live a richer life; monetarily and otherwise. Such lifestyle would help them spend more time with their families, stay healthier, pay more Zakah and develop more functional communities around them without having to increase their incomes.
The main goal of the organization would be to increase the number of Muzakkis among Muslims by choosing to only work with Muslims with jobs and business that are either under debt or are debt prone. The organization will purposely stay away from the “give it and forget it” charity model to develop a sustainable Riba-free lending infrastructure which would expand as the Muzakki base increases. As a non-profit, this organization will seek Zakah and Sadaqah monies from the Muslim community, philanthropic funds which are earmarked for sustainable initiatives, and other charitable funds.
It will also solicit in-kind donations, such as, used cars, durable goods, equipment, etc.; and finacial expertise. Those who don’t commit to live a Riba-free life should be refused services. The reason is that if they don’t make that comittment, they will use Interest Free Living’s services as a source of cheap financing and will continue to incur interest-based obligations in their lives and will most likely never be able to join the ranks of Muzakkis.
The main goal of increasing number of Muzakkis would be achieved through fiscal education, mentoring and Riba-free loans. Every client’s needs would differ and the organization may not be able to assist a wide varity of clients’ situations. Therefore, the organization may have to start from somewhere, for example, fiscal education, mentoring and car loans.
Let’s say Ahmed wishes to purchase a $15,000 car. He is able to pay as much as $300 per month for car payment, but does not want to buy a car on Riba basis. He basically has four choices:
1. Buy a used car with readily available cash: This may be a workable option if Ahmed has enough money to purchase a decent car to meet his short-term needs or has enough automotive savviness to drive his used car dollars farther.
2. Lease a car: This option is used by many Muslims and work fine for those who don’t mind having a car payment in their monthly bills forever.
3. Buy a car on cost-plus financing: This option is offered by a few Islamic finance companies and Ahmed may also be able to negotiate such arrangement with some dealerships.
4. Wait and accumulate enough cash to buy the car: This option may or may not work for Ahmed depending on the nature of his needs. If he just wanted to have a car for no specific reason, then this could be a viable option to stay away from Riba and debt. But if he needs a car to go to work, then this is irrelevant.
Here is one potential “full cycle” solution which Interest Free Living may offer to Ahmed:
When Ahmed contacts Interest Free Living and demonstrates his desire to live a Riba-free life along with the desire to be a Muzakki, he is evaluated for his financial needs. He can be assisted from the Zakah funds, if he meets the criteria of being a Gharim. Alternatively, he can be assisted through non-Zakah funds, such as, cars donated to Interest Free Living which generate tax breaks for the donors according to Publications 526 and 761 of the Internal Revenue Service (IRS).
Depending on Ahmed’s needs, Interest Free Living may either help him buy a used car from the market or may sell one of the donated cars at Kelley Blue Book (KBB) “Private Party Value.” In either case the organization makes a car available to him through a short-term Riba-free loan to meet his immediate transportation needs.
Unless sufficient funds are accumulated, the organization will most likely not get involved with home loans and educational loan. It will help with smaller and short-term loans. If Ahmed has other Riba-base debt to handle, the organization will help him with that. Otherwise, he will agree to save certain amount of money to purchase his permanent car by a specific date.
If Ahmed purchases the other car and brings back the car it purchased from Interest Free Living, the organization takes it back from him at the then KBB “Private Party Value” of the car. Due to the fiscal coaching by the organization to live a sustainable lifestyle of a Muzakki, Ahmed may decide not to purchase a more expensive car at this time and make use of Zipcar or similar services when he needs a newer car for social or business reasons.
Above is a brief description of how Riba could be eradicated, debt could be reduced, and the Muzzaki pool could be increased in the Muslim community in a sustainable manner. Evolution of the above ideas could be followed on this author’s website.
Liaquat Ali’s is the author of “Private Money: The #1 Solution to Eliminate Booms and Busts in Real Estate Forever!” Ali is currently pursuing an MBA in Management and Strategy from the Western Governors University and is the founder of TrulyInterestFree.com
Financial products in blatant disregard to Qur’anic verses 2:275 through 2:282 are “innovated” day in and day out by conventional banks and Wall Street with “Shariah Complaint” stamps. When you research those “Shariah Compliant” stamps you find out that those stamps were issued with an assumption that there are no options other than what was approved as “Shariah Compliant.”
Take Tawarruq, for example. This is a practice where a financial institution sells a commodity to Entity A on deferred payment basis. Entity A then sells this product to Entity B and gets cash. Entity A then uses this cash for its XYZ needs.
Entity A continues to make payments for the commodity it no longer owns. In essence of this series of transactions is that Entity A received an interest-bearing loan from the financial institution.
Now, if you monitor people in the Islamic Finance arena, they would continue to focus on the mechanics of the Tawarruq process, but they will not discuss the possibility that maybe just maybe the financial institution should come into a partnership contract with Entity A to meet its XYZ needs, share exposure to profit as well as loss, and avoid the fiqh gymnastics.
When you research why such partnership products are not brought to market, you will find that the financial institution does not want to get exposed to Entity A’s business risk, and Entity A wants to keep the financial institution away from its business because it thinks that the amount of money they would have to part in a debt scenario is cheaper than what it would cost them in a partnership arrangement.
So the conventional business wishes of both the financial insitution and Entity A were maintained by through fiqh gymnastics and the process was called “Shariah Complaint.”
The purpose of this article is to explore various financing opportunities which individual Muslims in the US and Shariah finance houses around the world could tap into to expand the riba-free transaction space in the country by providing stable and predictable investment options to investors and flexible and cost-effective funding options to real estate buyers.
Muslims’ understanding of riba, and their attitude toward it, varies greatly. Some believe that it refers to any kind of profit which is made on top of money and it is disallowed regardless of how you interpret it. Some believe that only excessive interest constitutes riba, and yet others believe that simple profit taking is allowed but compound interest is not allowed.
Then you have the Islamic finance arenas where theological and historical understandings meet conventional financial market instruments. The discussion gets even more nuanced in terms of the existence and interpretations of maysir (generally understood as gambling or speculation), gharar (generally understood as situations where consequences of transactions are hidden or worse misrepresented), and of course risk.
Due to the stern denouncement of riba in the Qur’an, the demand for riba-free transactions exists all around the world. In recent years various real estate financing products have hit the US market which claim to provide Islamic financing. Specific details about those products are beyond the scope of this article. However, it is important to note that the liquidity of those products is primarily provided by Freddie Mac (Federal Home Loan Mortgage Corporation) in the residential space, and by Wall Street “credit lines” in the commercial space.
The underwriting criteria of those Islamic finance outfits are therefore dictated by their respective money sources. Due to such criteria, a large segment of the Muslim population in the US is left without riba-free transaction options even if they wanted to conduct business with those outfits.
The only way to service this demand is to work with sources of money that, due to reasons of their own, are as eager to create riba-free transactions as those who demand them. These sources of money don’t necessarily need to be of Muslim origin as long as their investment needs are satisfied while creating end-to-end and transparent riba-free transactions.
This author‘s area of expertise is real estate investments and “private money” which he has used for his real estate transactions during the past six years. To him riba-free transactions are simply a special case application of the private money space. The author defines private money as the source of funds where the owner invests directly. Intermediaries if any have low or no influence on the transactions. The second requirement for the private money is that the terms are flexible, individually negotiated among principals and are not dictated by institutional indexes or underwriting criteria.
The first large source of “money” is equity in real estate. According to the National Association of REALTORS (NAR), as of February 2009, the size of “owner occupied” residential real estate was $20 trillion, and the size of commercial real estate was $5 trillion. According to Census 2000, 33% of all owner-occupied residential real estate in the US was owned “free and clear.” That is, there were no mortgages on those properties.
Due to the real estate boom and bust in the past eight years, the very houses which were “free and clear” may have been financed, and the houses which had mortgages on them may now be “free and clear” due to mortgage pay off or foreclosure. So until Census 2010 is released, we can safely assume that up to $6.6 trillion worth of owner-occupied residential real estate is available “free and clear.”
According to the Federal Reserve, at the end of the third quarter of 2008, the mortgage debt on commercial/multifamily properties was $3.4 trillion. This means that the owner equity in commercial properties is around 32% which is almost the same as the “free and clear” number for owner-occupied residential properties.
Additional drill down into a property’s title data, in terms of age of the owner and the length of ownership could reveal potential candidates for “free and clear” residential and commercial properties. It is safe to assume that older owners would have more equity in their properties, and may entertain alternative financing proposals.
Younger owners who may have mortgages may not be able to make independent decision. According to Census 2000, 33.4% of the US population was 45 years old or older which means that today approximately 33% of the US population is 54 years old or above.
The NAR reported that in 2008 approximately five million existing homes were sold in the US at an average of $198,000 each, for a total of $976 billion. If three hundred and six million Americans bought five million houses then it can be estimated that seven million Muslims bought approximately 114,000 existing homes at $198,000 for $23 billion.
The seven million figure has been estimated by Council on American Islamic Relations (CAIR) and was recently endorsed by President Barak Obama. If Pew Research Center’s 2.35 million number is used then Muslims bought 38,400 homes $7.6 billion.
According to a Shariah finance insider in the US, there have been only $2-$2.5 billion worth of Shariah finance mortgage originations including refinances thus far. This shows that the Shariah finance houses are not penetrating the market due to a variety of reasons, such as, indifference, price sensitivity, theological concerns and distrust of the Shariah finance products.
With the availability of $6.6 trillion in residential equity spread over more than 40 million residential “free and clear” units as per American Planning Association, Muslims can enter into riba-free transactions with Muslims as well as non-Muslims. These transactions could be carried out by totally by-passing intermediaries that must charge interest, profit or mark-up to sustain their existence.
This eliminates riba from transactions altogether and avoids the whole interpretation exercise of what riba is and what it is not. These transactions would most likely utilize murabaha or ijara contracts, and are limited to older, existing properties.
The second large source of funding is retirement accounts in the US. According to the Pension Research Council of Wharton School, those retirement accounts were estimated to be at $16.4 trillion in the fourth quarter of 2007. However, according to an Associated Press report they shrank to around $8 trillion after the economic downturn.
There are two broad categorizations of these retirement accounts. The “401(k)” is for employees of a corporation and the “IRA” is for self employed people. There are limits to annual contribution to these accounts, and the invested principal and return on investment are either tax deferred or tax free depending on whether the account holder paid tax before contributing to those accounts. The owners of these accounts cannot generally withdraw money from their accounts until they reach the age of 59 ½.
When the US Congress approved the Employee Retirement Income Security Act (ERISA) to create the IRA and 401(k) in 1974, it only prohibited retirement account holders from investing in life insurance and collectibles, such as, painting and rugs.
However, Wall Street firms, where more than 96% of these retirement accounts ended up, restricted investment options to stocks, mutual funds, bonds, etc. Wall Street does offer money market as a money parking option when investors get jittery due to the volatility of the market. However, as soon as the stock market recovers efforts are redoubled to get that money back into speculative financial instruments.
Due to the distrust of Wall Street, many of those retirement account holders have started moving their money elsewhere, such as, Self Direct Individual Retirement Accounts (SDIRA), specialized life insurance policies, and other investment options. Unlike Wall Street, SDIRA custodians allow the full range of investing options as allowed by the ERISA, that is:
1. Residential real estate, including apartments, single family homes, and duplexes
2. Commercial real estate
3. Undeveloped land
4. Real estate notes (mortgages and deeds of trust)
5. Promissory notes
6. Private limited partnerships, limited liability companies, and C corporations
7. Tax lien certificates
8. Foreign currencies
9. Oil and gas investments
10. Publicly traded stocks, bonds, mutual funds
11. Private stock offerings, private placements
12. Judgments/structured settlements
13. Gold bullion
14. Car loans
15. Factoring investments
16. Accounts receivable
17. Equipment leasing
Even though only 4% of retirement accounts were thought to be managed by non-Wall Street custodians before the recent stock market meltdown, the money exodus out of Wall Street would take hundreds of billions of dollars into SDIRA accounts.
Unlike Wall Street, the SDIRA custodians currently operate strictly as “money holders” and do not provide investment advice. Therefore, there are huge market opportunities for financial houses of all types to provide investment products to these self directed retirement account holders.
At the current per capita income of $48,000 for the US population, seven million Muslims have a cumulative GDP of $336 billion. It is safe to assume that each Muslim has an equivalent of 6 months to one year’s worth of income saved up. That would be around $168 billion to $336 billion. As the general population moves towards SDIRAs, Muslims will move their money there as well.
If the total retirement account value of $8 trillion is proportionally applied to the Muslim population, they have $61 billion in their retirement accounts if Pew’s population estimate is used. They have $183 billion if CAIR/Obama population estimate is used.
With the rapidly growing SDIRA capital from its current value of $320 billion (4% of $8 trillion), and several billion dollars in Muslim retirement accounts, Shariah finance houses can provide investment products to Muslim as well as non-Muslim retirement account holders to satisfy their flight-to-safety needs after being burnt by Wall Street’s never-ending maysir (speculation) and gharar (uncertainty.)
Shariah compliant contracts among Muslims and non-Muslims can be created for real estate and other investment products; as allowed by the ERISA. The state and federal securities laws, corporate structuring and the US legal system provide individuals and institutions with the ability to craft and enforce such contracts.
This will resolve the thorny issue of the availability of “willing and stable” sources of funding which prevented organic Shariah compliant financing products to take root in the US in the past.
Liaquat Ali is the founder of http://www.TrulyInterestFree.com and can be reached at lee [at] trulyinterestfree [dot] com or 203-953-6490.