Islamic Law Closing Principles
An Islamic Law closing operates under the principles of Fiqh al-Muamalat (Islamic rules on transactions).
Basically, this principle of Islamic Law is one in which there is sharing of profit and loss and the prohibition of usury interest (known as riba). Because of these principles, the transaction is structured different. You should know these differences before proceeding to the closing.
How they are Structured
An Islamic Law closing can be structured several ways. The three basic and most common are as follows:
1. Ijara. This works like a leasing arrangement: the bank buys the home for the customer and then leases it back to them. Different forms of leasing are permissible, including those where a portion of the installment payment gets credited toward the final purchase.
2. Murabaha. The bank supplies specific goods for resale to the customer. the parties a mutually agreed to a contract within a mutually negotiated margin. This is the least popular method and you are unlikely to see Murabaha.
3. Musharaka. This is a joint venture. The customer and bank contribute to the capital of the operation (the home in this case) and agree to share the returns (as well as the risks) in proportions agreed to in advance. The parties will usually own the home jointly. The bank may set up a limited liability company to own its portion. Under the LLC agreement, the banks interest in the LLC declines as payments are made to the bank.
* Islamic Law closings are restricted to transactions acceptable to Islamic Law. The acceptable transactions exclude those involving alcohol, pork, gambling, etc. This is to promote in only ethical investing and moral purchasing.
* Central to Islamic finance is the fact that money itself has no intrinsic value. Money is simply a medium of exchange. Each unit is 100% equal in value to another unit of the same denomination. Under Islamic Law you are not allowed to make a profit by exchanging cash with another person. A Muslim is not allowed to benefit from lending money or receiving money from someone.
Closing Documents that are different
Depending on what type of Islamic Law closing you will do, you will see different closing documents for signing. What you are likely to see are:
1) Obligation to Pay. This will be used instead of a Note. No interest will be listed in this obligation. There will be listed the original balance and monthly payments. The payments will be made payable to the "co-owner" (usually but not always a Limited Liability Company set up just for this transaction) and not a bank. The rest of the terms and conditions are generally similar to a note.
2) A Limited Liability Agreement. If the deal is structured with a co-owner, then you may see an agreement to pay the costs associated with the formation of a Limited Liability Company (LLC). These are usually nominal fees. Remember the LLC is the co-owner of the property.
3) A Co-Ownership Agreement. This is the actual agreement between the consumer and the LLC where they agree to own title to the property jointly.
4) A Co-Ownership Commitment Agreement. This is where the consumer and LLC both agree to the terms of the transaction. Usually, the consumer agrees to pay an Acquisition payment at closing as part of their "risk" in the transaction. The LLC will provide the remaining funds at closing.
***Please note that you will also have the usual disclosure documents and security instrument at closing. These documents will reflect the underlying transaction and will show no interest or interest rate being paid. It will look a bit strange to you at first.
I have samples of each of the documents listed above. I will be happy to provide you with redacted copies. Out of an abundance of respect, I have not linked to them here so simply contact us below and ask for the Islamic Law closing documents and I will e-mail them to you.
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