Interest Rates and Religious Principles

The Koran forbids "riba," an Arabic word that can be translated into "usury." Strict interpretation of the Koran leads to the prohibition of receiving or paying any interest. According to the article in the New York Times by Shira J. Boss, the original intent of the prohibition was to "protect poorer classes from exploitive money lenders." Low rate caps on loans in the U.S. have had much the same motive. While scholars debate whether the intent of the Koran was to prevent the charging or receiving of any interest or just "high" interest, strict Muslims still face challenges in obtaining home mortgage loans that do not involve the payment of interest.

The increasing numbers of Muslims that have come to the United States and who wish to adhere to a strict reading of the Koran are seeking Muslim banking. Since the Muslim bank cannot receive interest and the Muslim borrower cannot pay interest, they have a problem. One approach has been for the bank or finance company and borrower to invest jointly in the new home, which is leased to the "buyer." The homebuyer then makes monthly payments to the finance company. These payments are allocated between the finance company and the homebuyer. "If, for example, the finance company puts up 70 percent of the purchase price, it would receive 70 percent of the rent -that is the return on the investment. Since the homebuyer pays off a portion of the capital each month, the institution's ownership share in the house declines. Therefore, its percentage of the rent would also decrease. Eventually, the homeowner would repay all of the capital and the payments would cease. An Islamic finance company, American Finance House-Lariba has developed such a plan with the added twist that it has arranged to make a suitable portion of the homebuyer's payments tax-deductible. In addition to the tax benefits to consumers, the arrangement also permits the finance company to obtain financing from Freddie Mac.