How Does a Halal Mortgage Work?

Because Sharia law prohibits riba, or loans that charge interest, conventional mortgages are forbidden for practicing Muslims. To meet the spiritual and financial needs of Muslim homebuyers, a number of Canadian lenders are now offering halal mortgages.

Many Canadians might associate “halal” with food, but the term actually applies to Muslim society in general, and describes behaviours and activities — including lending — that Islam deems permissible.

Halal mortgages eliminate the payment of interest by using different legal and payment structures. Let’s find out how they work and where they’re available in Canada.

What ‘halal’ means for a mortgage

According to Sharia law, riba is seen as exploitative: borrowers are forced into a never ending cycle of debt at the expense of lenders, who reap continual profits.

That doesn’t mean halal mortgages remove profits from the equation. Instead of interest rates, a halal lender might charge a “profit rate”. Even though these profit rates can be based on the Bank of Canada overnight interest rate, they tend to be higher than the rates attached to conventional, non-halal mortgages.

The increased cost is due to a variety of factors, including a general scarcity of available capital to lend out, as well as increased financial risk to the lenders since Islam also restricts mortgage foreclosures.

Consumers can generally expect to pay up to an additional 4% for a halal mortgage compared to a regular mortgage from one of the major banks.

How halal mortgages work

Qualification requirements for a halal mortgage in Canada

The qualification requirements for halal mortgages in Canada will depend on the provider. They will likely review your income, credit history, and may require a down payment of at least 20%. Halal Financial Corporation, however, requires a minimum down payment of 25%.

Halal mortgage prepayment privileges

Some halal mortgage lenders offer prepayment options similar to those available at mainstream banks. You might be able to prepay up to 20% of your original mortgage balance in a calendar year.

With prepayment privileges come the risk of prepayment penalties. Some halal lenders treat excess prepayments the same way Big Six banks do, by charging either three-months’ profit or by using a proprietary Profit Rate Differential to calculate the penalty.

Halal mortgage term lengths

With a halal mortgage, term lengths differ from lender to lender. Some offer shorter terms of one to five years, others offer terms that run the length of the mortgage — sometimes as long as 25 years.

Types of halal mortgages

Murabaha

Under a typical Murabaha agreement, the financier buys the property and immediately sells it to you (the customer) at a higher price that includes a profit. The amount of profit is based on a number of factors including your risk profile, credit history, deposit amount, the property value, and repayment term.

Instead of owning the property as an individual, you hold the property title within a corporation that you set up for this purpose. Unfortunately this makes you ineligible for the land transfer tax rebate available to first-time home buyers in some provinces.

There are, however, variations of Murabaha available in Canada where the borrower assumes ownership of the property directly without having to take the step of purchasing it through their lender.

Ijara

An Ijara mortgage is similar to a rent-to-own scheme. The financier buys the property outright and rents it to you for a fixed term. Over this term you make regular steady payments, which are a combination of rent, repayment of capital, and profit for the financier. At the end of the agreement, ownership is transferred to you.

Musharaka

With a Musharaka mortgage agreement, both you and the financier own the property jointly. Your payments are a combination of rent for the portion of the property owned by the financier, and property purchase payment to buy a little bit of financier’s share until eventually, at the end of the term, you own the whole property.

Like typical Western mortgages, halal mortgages offer a variety of terms, conditions and fees. Some Murabaha agreements, for example, do not allow for additional payments, while some Musharaka mortgage customers can pay up to 20% extra per year without penalty.

Where to find a halal mortgage in Canada

An Islamic mortgage in Canada can currently be obtained through the following lenders:

Eqraz and Manzil are both members of the Accounting and Auditing Organization for Islamic Financial Institutions. The AAOIFI is an international not-for-profit organization located in Bahrain that regulates Islamic finance organizations and offerings to be Shariah-compliant.

The Canadian Halal Financial Corporation is not a member of the AAOIFI, but it does adhere to the organization’s standards and has had its products deemed halal by experts in Sharia law.

In addition to the three Canadian halal mortgage providers, there is also a US-based company called IjaraCDC that offers halal mortgages to Canadians.

Halal mortgage challenges in Canada

With halal mortgages being an emerging product in Canada, and Canada’s tax law posing some unique challenges to Islamic mortgages, it can be hard to know which mortgages are truly compliant with both Sharia and Canadian laws.

According to the Eqraz website, Musharaka mortgages may be non-Shariah-compliant with the use of interest-bearing secondary contracts.

Eqraz also suggests that both Musharaka and Ijara mortgages are incompatible in Canada for a variety of reasons, including double capital gains and land-transfer taxation, GST/HST-taxable maintenance responsibilities, and, in the case of diminishing Musharaka mortgages, complications regarding who takes on the downside risk despite co-ownership of the property.