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Islamic banks do not give loans they invest in financial activities of their clients. Am I correct?

If yes, then how can they provide loans for housings? Home loans have nothing to do with business.

Then how do they manage this type of loans?

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If the customer pays 20% of the payment in advance, then he is he owns 20% of the house and the bank owns 80%. Now they say he pays the rest of the amount and also the rent of the house until he becomes the sole owner of the house.

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As I understand it, if the "borrower" puts a down payment of 20% and the bank puts down 80%, then the bank and the "borrower" own the home jointly as tenants in common with a 20%-80% split of the asset amongst them. The "borrower" moves into the home and pays the bank 80% of the fair rental value of the home each month. {Material added/changed in edit: For the purposes of illustration, suppose that the "borrower" and the bank agree that the fair rental per month is 0.5% of the purchase cost. The "borrower" pays 80% of that amount i.e. 0.4% of the purchase cost to the bank on a monthly basis. The "borrower" is not required to do so but may choose to pay more money than this 0.4% of the purchase cost each month, or pay some amount in a lump sum. If he does so, he will own a larger percentage of the house, and so future monthly payments will be a smaller fraction of the agreed-upon fair rental per month. So there is an incentive to pay off the bank.}

If and when the house is sold, the sale price is divided between "borrower" and bank according to the percentage of ownership as of the date of sale. So the bank gets to share in the profits, if any. On the other hand, if the house is sold for less than the original purchase price, then the bank also suffers in the loss. It is not a case of a mortgage being paid off from the proceeds and the home-owner gets whatever is left, or even suffering a loss when the dust has settled; the bank gets only its percentage of the sale price even if this amount is less than what it put up in the first place minus any additional payments made by the "borrower".

I have no idea how other costs of home ownership (property taxes, insurance, repair and maintenance) or improvements, additions, etc are handled. Ditto what happens on Schedule A if such a "loan" is made to a US taxpayer.

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  • Re: tax. The property changes hands twice; depending on the applicable law, it is possible for both transactions to attract tax and stamp duty, making this type of mortgage more expensive.
    – user3490
    May 19, 2012 at 20:40
  • Sorry to dig up this old thread, but is the monthly rent then linked as a percentage to the initial price or market price?
    – SMeznaric
    Jan 18, 2017 at 17:56
  • @SMeznaric The monthly rent is whatever is agreed to between the bank and the purchaser, which of course can be expressed as a percentage of the initial price of the house. And banks could presumably compete with respect to the monthly rent, with the purchaser wanting to go with whomsoever agrees to the least monthly rent. If the rent is to increase, say annually, then this would also be part of the agreement between the bank and the purchaser, etc. Ask the other answerer Fahad Uddin for more details; his is the accepted answer.
    – Dilip Sarwate
    Jan 18, 2017 at 22:41
  • So in case if you repay early, they will charge you the initial purchase cost not the market price? If so, sounds like the Islamic mortgage is effectively the usual mortgage with an embedded American call option.
    – SMeznaric
    Jan 19, 2017 at 0:29

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