Chicago Tribune Real Estate Cover Story
O ye who believe! Devour not usury, doubled and multiplied; but fear Allah; so that you may be successful.
3-130 Surah Al-Imran Verses
Taj Khan had resigned himself to renting a home for his family of three for a very long time. Devout in his practice of Islam, the 28- year-old computer network administrator is particularly concerned about avoiding any business transactions that entail charging or paying interest.
"Interest is one of the biggest things we are specifically told to avoid," Khan says, "so I wasn't going to be able to buy a house. I wanted to buy, but my religious belief was stopping me."
He was trying to save toward an all-cash purchase, but the pressures of supporting a young family kept him from putting much away. So Khan figured he and his wife, Seemab, would go on renting part of his father's Hanover Park house indefinitely.
"If I couldn't find a way to buy in a religiously good way," he says, "I would just keep on renting."
Then last year Khan heard through friends about an interest-free Islamic home-buying program that was launching at Chicago's Devon Bank. Instead of buying a house and taking a mortgage from a bank to pay for it, under this program the buyer picks a house, but the bank buys it and immediately sells it to the buyer at a sizable markup.
The bank calculates its markup based on prevailing interest rates. Thus, because the total price with markup is the same as what the buyer would have paid on a 30-year loan with interest, the buyer is agreeing to pay just as much as a homeowner with a standard mortgage would pay. The difference is that it's a credit sale for a set total price, not an interest-bearing transaction.
But that's only true of the transaction between the home buyer and the bank. When Devon Bank later sells the loan to Freddie Mac, as many mortgage lenders do, what it sells is a standard interest- bearing loan, with the same profit structure for both sides. Essentially, the bank has wrapped a standard mortgage in non- standard terminology that satisfies Islamic teachings.
Although it might sound like a paperwork trick, it finesses a fine point in Islamic law, or shari'ah, that makes all the difference to Khan and other U.S. Muslims who want to own homes but decline to get into any financial transactions that charge interest.
Khan bought a four-bedroom house in Bartlett last summer, confident that the purchase was in compliance with his faith because of the structure of the deal. He picked a house whose price was $295,000. Devon Bank bought it, and accepted a $60,000 down payment from Khan. His agreement with the bank calls for 360 monthly payments of $1,338. In the end, with all payments and the down payment, he will have spent a total of $540,000 for the house.
Had he bought with a standard, interest-bearing mortgage, his 30- year total would have been approximately the same.
"From a financial standpoint there may not be much difference, but what matters is the way you conduct the transaction," says Salman Ibrahim, a member of the Shari'ah Supervisory Board of America, a West Rogers Park panel of 10 Islamic scholars that monitors financial products targeting Muslims and gave its approval to Devon Bank's program. "The taste of a chicken does not change whether it is zabiah [slaughtered according to Islamic practices] or non-zabiah; what changes is the way you slaughter it."
Two Chicago banks -- Devon Bank and Broadway Bank, both small North Side institutions in neighborhoods where large numbers of Muslims live -- both started shari'ah-sanctioned home-buying programs in 2004. Neither bank's officials will say how many Islamic home transactions they have conducted, though both say the programs have been received well by their customers.
"For us, it's a service issue," says Demetris Giannoulias, chief financial officer of Broadway Bank. "There is a demand for this kind of thing in the community we serve, and if it requires us to do a little extra amount of service to make home buying more palatable to the customer, we'll do that."
In January the larger of the two banks, Devon Bank, took a big step forward when it announced that national mortgage investor Freddie Mac will buy its Islamic home deals, giving the bank the leverage to offer its Islamic products in other states. By mid- January, Devon Bank had begun offering the products in 10 states outside Illinois, with more states to be lined up soon, according to the bank's corporate counsel, David Loundy.
A measure of the pent-up desire for this religiously appropriate method for Muslims to buy houses: "When he heard about it, a guy from Connecticut started calling us three or four times a day until we got approval there and could say yes to him," says Nazir Gurukambal, Devon Bank's vice president in charge of the Islamic home-buying program. (The bank is awaiting final regulatory approval to offer its program in Connecticut.)
Mohammed Monawer, an engineer with Wisconsin's Public Service Commission, says he called Devon Bank as soon its product became available to him last fall, as he had been renting with his family of four for more than 15 years.
"An Islamic option was never available before, so I kept renting," Monawer says. When a group of Islamic scholars in his city determined that "the way Devon Bank is doing it is in compliance with the Islamic way, I got on the bandwagon."
Monawer uses credit cards because he's found there's no other way to secure hotel reservations and conduct some other business, but he diligently pays the balance each month, eliminating interest charges.
He had rented a two-bedroom apartment in Madison for his family of four long past the age when a professional typically can buy a house, but he had no other choice that would fit his religious needs. Monawer and his wife, Safia, had been saving to buy for years, but they only had about 20 percent of what a suitable home would cost.
In November, they bought a three-bedroom house on a half-acre lot in Fitchburg, a suburb south of Madison. "It's a nice neighborhood, and quiet," he says. "Our condition is improved, but we are happiest because we didn't have to compromise our beliefs to get this."
Notwithstanding the exuberance of individual home buyers, there's no sure measure of how big a demand there is for Islamic-friendly financing. A study by HSBC, a New York bank that offers similar Islamic products, indicated that fewer than one in 10 U.S. Muslims use Islamic-based financial services, and that 64 percent of the nation's Muslims have bought homes using standard interest-bearing mortgages. That could be simply because shari'ah-compliant loans weren't available in the past, as new homeowner Khan notes.
"Eleven years ago, when we came to this country, my father needed to buy a house and couldn't afford to look at it from an Islamic perspective," Khan says. "There wasn't anything; he didn't have a choice."
In fact, while the Islamic stricture against borrowing with interest goes back centuries (Judaism and Christianity had similar prohibitions), the desire among Muslims to avoid interest is relatively modern, says Mahmoud al-Gamal, professor of Islamic Economics at Rice University in Houston.
"In the early 20th Century, most Islamic countries were basically trying to emulate the West in their rules and institutions," he says. "But since the revolutions and the religious resurgence of the 1970s, you have this premise that Western-style finance is not acceptable anymore."
But al-Gamal notes that these programs have to have one foot in each of two canoes: They have to satisfy a Muslim's religious practices at the same time that they fulfill U.S. banking regulations and practices.
"The job of the lawyers is to make sure that while the language in the contracts makes the customers convinced there is a difference from a mortgage, in fact the difference is negligible or nonexistent, so the buyer of the loan, the Freddie Mac, is happy that this is a Freddie Mac note like any other Freddie Mac note," al- Gamal says.
While it's pretty easy to calculate how much an interest-bearing loan will cost in 30 years and translate that into a markup (it's about the same as the figure shown at the bottom of a standard borrower's Truth in Lending form at closing), keeping the Islamic purchase "clean" creates three dilemmas for the buyer and the bank. They have been resolved with differing levels of clarity.
The first and simplest is the extra cost of what Devon Bank's Loundy calls "the COBM: the cost of being Muslim." If getting a home in a way that adheres to one's religious principles means shelling out a prohibitive additional sum, customers will feel that the cost is too high and keep renting. Loundy says his bank has tried to ensure that this fee is minimal, just enough to cover the cost of processing two deeds (one for the sale to the bank, the second for the sale to the buyer) instead of just one. He estimates the extra cost to be about $100. In Madison, Monawer says his additional costs came to about $750, not enough to scare him off.
The second dilemma is vastly more complicated. Few people buy a house with a 15- or 30-year loan and stick around for that whole term. With an interest-bearing loan, that's no problem. Sell the house, settle the debt still owed to the bank, and walk away with what's left. But because a buyer using an Islamic purchase plan isn't paying interest, how much debt is left if he or she sells before the term is up?
It's further complicated by the fact that most homes will be worth more on their next sale than the purchase price.
Pure Islamic finance instructs that risk should be shared by both parties, al-Gamal says; that would mean the bank and the home buyer would share any increase in home value, and that if the value drops, the buyer would owe less. These ideas are counter to the way American home financing is devised.
Loundy and al-Gamal both say this is a very thorny issue. It would be disrespectful to even offer a payoff schedule, because that blurs the line between paying interest and paying the Islamic way. The whole idea is that these buyers intend to pay the cost of the house in full over time. That's why most buyers in the program agree to accept the uncertainty and go in with no promise of how it will be resolved if they sell early, Loundy says.
"There's no other way to work it out but to leave it undecided," he says.
The third problem is similarly left unresolved, but it tests the home buyer's dedication to religious principle. Every year at tax time, millions of American homeowners cash in on their most lucrative tax break, the deduction for mortgage interest they have paid. Because it amounts to thousands of dollars for most people, it's a major factor in what makes a home affordable.
Here's the problem for buyers in Islamic programs: To comply with mortgage regulations, the bank has to report the amount buyers paid that would have been interest in a standard loan. Should the buyer take advantage of that deduction, then, or stand on principle and refuse the deduction because it is premised on paying interest?
Loundy and al-Gamal say the IRS has not yet determined what it will require, which means Islamic buyers have to decide for themselves.
Ibrahim, of the shari'ah board, says the concept got a lot of debate, and ultimately the board said that "we would prefer to have some sort of preferred shari'ah-compliant deduction [that reflected the markup] and not the interest, but because there is nothing of that type at this point and because it would be brutal to these Muslim consumers to have to go without the deduction, the board would go ahead and allow taking the deduction."
Without taking that deduction, most Islamic buyers would find that their "cost of being Muslim" was way too steep.
