Conventional mortgages generally involve the lending of a capital sum to a borrower who will then repay the amount borrowed in addition to a fixed or fluctuating interest rate, or a combination of both, over an agreed period of time. On completion of a property purchase with a conventional mortgage, the ownership of a property would pass directly from a seller to a buyer, with the lender’s charge being noted on the title of the property, until the repayment of a loan is completed.
Diminishing Musharakah Financing Products (“DMFPs”) are alternative finance products developed to comply with Islamic finance principles known as the Sharia. One of the key principles is the prohibition of Ribah, which is the generation of income or profit by charging interest. Lenders offering DMFPs have their own Islamic Advisory Committees, which consist of Islamic Scholars that advise on how their products could be designed to best meet the principles of Sharia.
DMFPs apply the principles of co-ownership, and are generally structured in a way that the Financial Institution contributes towards the purchase price of a property as a co-owner, rather than a lender, and effectively co-owns a property with the Buyer on completion. The equitable shares in the property are proportionate to the amount of capital contributed between the Financial Institution and the Buyer. A Diminishing Musharakah (ie. a diminishing co-ownership) agreement would be entered into between the Financial Institution and the Buyer regulating the split of beneficial interest in the Property between them.
The legal title of the Property is owned by the Financial Institution on completion of a purchase, and a lease is created between the Financial Institution and the Buyer under which the Financial Institution charges the Buyer rent on its share of the Property. As such, the Financial Institution does not earn any interest, and rather collects its income by the profit generated by rent.
The Buyer effectively, makes repayments to the Financial Institution on two separate elements as set out below over a period of time in order to acquire complete beneficial interest in the property:-
- Acquisition payments to buy the Financial Institution’s share of beneficial ownership, which is fixed at the same price as the FI’s initial contribution to the purchase price.
- Rental payments under the lease in respect of the Financial Institution’s proportion of beneficial interest in the property.
A Buyer’s equitable share would increase as they make their Acquisition payments and the rental payments will accordingly adjust throughout the term. The Financial Institution would transfer the legal title of the property into the Buyer’s name when the Buyer has completed their Acquisition payments and as a result there would be no further rental payments required as this point as the lease would come to an end.