Economic System of Islam- An Alternative to Mortgage II

Summary of 8.19 An Alternative to Mortgage I

Suppose one had a house worth $50,000 and the mortgage is up for renewal and one still owes the company $40,000.’ What was suggested was that one divides the value of the house into 50 $1000 shares and then you can sell forty shares (besides your own equity) to other investors who are interested and who can provide you with $40,000 which can be used to retire the mortgage or in some cases it can be used to purchase the home.’ The investors are rewarded by determining the gross rental value of that property, our assumption in the example was $450 a month and $5400 a year minus the main expenses (taxes and insurance of $900).’ This gives us the net rental value of $4,500 or $90 per share.’ The home owner doesn’t have to pay that full amount because they have to deduct the portion of the shares that he already owns.’ So he can subtract $900 ($90 multiplied by 10 share that he owns) which leaves $3600 rent due to the investors.’ We said that in order for the home owner to accumulate equity he would be allowed in accordance with the contract and mutual agreement to buy back some of those shares every year.’ The assumption that is made here is that he can afford to buy 3 shares per year.’ Assuming that the shares are worth the same price and each share is worth $1000 he would pay $3000 for the 3 shares.’ So he would pay a total of $6600 per year which is a monthly payment of $550 which in fact is less than what he would pay for a mortgage at most rates.’ In the second year and every subsequent year all you have to do is update the basic update based on the new appraisal of the property.’ In this case it went up the next year by 10% so the house was worth $5,5000.’ This means that the price per share would go up by 10% to $1,100.’ The new fair rental value may have also gone up by 10% (could be less but it is what was assumed) which gives us $5950-$990(updated expenses) which give.’ Then new rental value is $4960 for the next year which if divided by 50 chairs comes to $99 a share.’ Similarly the owner would have to deduct his share of 13 shares.’ This shoes that his portion of ownership has increased and the portion paid out to other investors would decrease.’ This gives us a total of $3663.’ Again he would have to buy 3 shares back at the new price of $1100 per share.’ So that total payment in the next year would be fore $6963 which is a monthly payment of $580.’ Still the person’ comes out on top and accumulates much larger equity than he would otherwise accumulate through the traditional mortgage systems and still with very affordable monthly payments.

8.20”” An Alternative to Mortgage II

Host:’ What is a program like Islam in Focus doing talking about the topic of home ownership?

Jamal Badawi:

In the Western civilization the term religion is used to refer to a set of beliefs, values and devotions.’ What is forgotten here is that in the case of Islam it is not only a religion in that sense but it is a comprehensive way of life that deals with all aspects of human living.’ Part of that living are the economic problems of mankind.’ In fact one of my major motives for trying to develop that system, even though the idea is not new, is the fact that Islam prohibits usury or interest in the modern term while allowing and encouraging people to participate in ventures on the basis of equal sharing in Prophets or losses.’ This is not only significant as a concept for Muslims, in order to avoid dealing in usury, but I am sure it would be of interest to those who mind the high interest rate.’ I have not found anyone yet who doesn’t mind that rate.

Host:’ How is the fair value of the property determined?’ What happens if there is a dispute abut the fair market value of the property?

Jamal Badawi:

The basic rule is the mutual agreement of the investor and the homeowner as to what is the fair value.’ But a impartial opinion can be acquired by someone who has professional training in property appraisals.’ If there is difficulty accepting a particular appraisal one could get two appraisals and take the average.’ However it seems that most of the appraisals would give similar estimates because they have certain formulas they apply plus some consideration of the market value.’ Two appraisals can be done but the cost would of course increase.’ It can be specified in the contract how appraisals are acquired and agreed upon.

Host: How much does an appraisal cost and who would pay for it?

Jamal Badawi:

I mentioned in the previous program that one property in Halifax is under the SER system.’ In that particular case it cost $150 to get a professional appraisal.’ My feeling is that the cost of this should be shared by all because it is part of the cost of running the property.’ I think that this can be deducted from the gross rental for the year which will distribute the load in proportion of the shares.

Host:’ To divide the property into shares does this include formally issuing shares in the form of documents in the same way as one might buy shares from companies?’ What is done about the title?’ Why $1000 shares?

Jamal Badawi:

A formal document can be issued if that is what is desired.’ I however, don’t think that this is needed.’ One has the full legal guaranties if one has the owner and investors sign a document which holds the property in collateral until all the principle as well as the profits are totally paid for.’ The document could specify what shares each party owns.

Second, the title doesn’t necessarily have to be changed.’ Even mortgage companies themselves don’t ask you to change the title.’ The title is simply held by them till you pay your mortgage.’ So there is no need to change titles.’ However if one persues this within a group, corporation it is quit possible that it can be set up as a housing co-op.’ The housing co-op would hold titles of all the properties under the system and when everything is paid off the title can be transferred back to the homeowner.’ This is flexible and does not have to be done.’ If it is done every year the title has to be changed because the portion of shares undergo some changing which requires lots of taxes and cost which are not necessary.

The shares being a $1000 is not a magical number.’ The shares could be $10, $100 etc. there is no reason behind the number.’ In fact if there is a credit union the share can be as small as $5 per share in the credit union.’ I just suggested that figure as a convenient figure, because when a house is worth $50,000 one would not go around collecting $10 and most people who want to make investments can possibly make a $1000 investment per share.’ However, if one wants to apply this in a Mosque, Church group or club where there are people who are not very well off but are willing to participate but not too many can afford more than $500.’ One can reduce the value of the share to $500 and increase the number of shares available.’ It doesn’t make a difference what the value of the share is if it’s an agreeable and practical figure.

Host: How can you charge rent to a home owner for the use of their own home?

Jamal Badawi:

If one totally owns their home and no one else has any claim on it then obviously no one is going to charge you any rent. When we talk about a home that is worth $50,000 and one only owns $10,000 which means it is not fully your own home.’ In a system like this the mix up happens because the concept is totally different than a traditional mortgage.’ In the case of mortgage you are truly not paying rent to the mortgage company but interest because you are a borrower and the mortgage company is a lender.’ Under this system the how owner is not a borrower and the investors are not lenders they are all co-investors including the homeowner.’ It is just like you and I owning a home, you own half and I own half but one of us needs to live in it.’ So I rent it to you if you need to live in it.’ It is fair’ that we both own it and we rent it to each other.’ Of course we would both share the rental value and thus you would only have to pay me half of the rental value.’ It is really a concept of sharing in the consequence of the whole deal.’ Obviously it is unfair for the investors to contribute the money, without getting interest or rent.’ There must be a fair return for them.’ And the closest thing that would give them a return would be a rental agreement.

Host:’ How is the rental value determined?

Jamal Badawi:

It can be determined in the same manner as the determination of the property value.’ The person making the appraisal of the house can also tell you what is the fair rental value of the same property.’ This information is readily available and people in fields with rental departments have this information readily available.’ However, this is similar to the appraisal of the value of the property and is a matter of mutual agreement and what is regarded as a fair rental value.

However, as a rule of thumb the rental value can be determined to be a certain percentage of the value of the property.’ I think anywhere between 3/4 of a percent to 1% as a monthly rental value is not unreasonable which seems to be the average that is found in the market.’ This could be incorporated into the agreement and would resolve this whole problem.’ We are talking about a gross rental value not including rental expenses.

Host:’ What are included as legitimate expenses and are deducted from the gross rental value and which ones are not?

Jamal Badawi:

There are a few items that I have no doubt about including.’ One are taxes or insurance.’ When someone rents a home or apartment they do not pay taxes nor do you pay insurance.’ Since the whole concept is shared equity and rental then it is only fare that these basic expenses are shared by all the investors. ‘The rental value would be the equivalent to a house that one would rent in similar conditions and areas.’ This should be levied against all the share holders and that is why we deduct these expenses from the gross rental.’ It is useful to add a few dollars to cover minor repairs like maintenance (leakage or painting every few years).’ This again is the practice and when a home is rented the home owners are responsible for these basic repairs.’ Of course in this case the home owner is part owner and the share holders are part owners so they should all share it.’ So this should all be deducted from the gross rental value.

Things like grass cutting and snow removal should not be included in the shared expenses because the normal practice when renting is that these things are taken care of by the tenants.’ It should not include any basic capital or improvements onto the house like building an extra room.

Host:’ What happens when improvements or additions are made to the house?

Jamal Badawi:

Again this has to be specified.’ One can not prevent the home owner from improving the property for the 14 years (example) of the contract.’ There a few alternatives.’ One, is that all the investors share the cost of improvement because it would reflect on the value of the property which would in tern reflect on the value of the shares.’ The appraisal of the property would go up not only by inflation but also because of the added improvements.’ In this case everybody, homeowner as well as investors, can share the cost of improvements by spreading it out proportionally to the number of shares each of them holds.’ The other possibility would be to let the homeowner make this improvement of and then issue him 3 shares (example) and in subsequent years it would be the price of the current share price.’ This means that the formula stays the same except that the total number of shares would vary.’ In the previous example we assumed there were 50 shares and when he spends the extra money it changes to being 53 shares.’ Now his share would start at 13 shares instead of ten.’ Gradually he would build up more and more shares.’ This is just a technical issue and not a major problem at all.

Host:’ Is there a price that one has to pay in order to acquire equity so fast?

Jamal Badawi:

As we showed in that example one can build $3000 in equity per year at $550 monthly payment on a $40,000 in investments.’ I agree that this is beyond imagination.’ Most people only get $100-$150 per year out of all the payments they make.’ Plus, under a mortgage one has to pay taxes and insurance while in this system that is covered.’ Under a mortgage agreement when one contributes $150 per year to their principle the total amount of principle remains the same from year to year.’ In other words one borrows $40,000 and it remains that way for the 20 or 30 years of the mortgage with very minute deductions to the principle every year.’ In this system one contributes allot more in thousands to the principle but in the mean time during the following year when one wants to buy shares one doesn’t buy them at the original price of $1000 but at the new market value which could be 10% more.’ And every year one buys the shares at the increased price.’ I still believe that this is a very fair and reasonable system.’ I did make some computations about that and the total payment under the SER system as compared to a mortgage would be equivalent to a 13-14% mortgage depending the appreciation of the property.

Host:’ If a home owner purchases more shares than the 3 who receives the money?

Jamal Badawi:

There are two ways of doing this.’ If all investors want this to be a long term investment and are not in a hurry to get their money back the money received from shares purchased by owners could be distributed among them in proportion to their shares.’ This means that everybody would have a proportional reduction in the number of shares that they own.’ However, the system is very flexible, with the consent of the others, one could agree with the investors that a certain person gets some of his/her money back when the owner buys back some shares which would mean that one is reducing their holdings from 10 shares to 7 shares.’ This can be worked out between investors anyway they like.’ It is a very flexible system.

Host:’ Is there any benefit from the investor’s point of view in investing in a scheme like this verses investing in other schemes?

Jamal Badawi:

First of all the renter gets the rental income every month which comes close to 9-10% of the investment.’ He gets an appreciation of the value of his shares which is compounded at about 10% per year (used as the example).’ Third he also gets the monthly payment by way of cash which can be reinvested and would be a third source.’ The main price here is that one has to be fair and expect to participate in smaller increase or even decline in the value of the property which makes it fare for both sides.

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