No-Interest Financing Expands Access to Homeownership
By Adam Korengold | August 11, 2016
Financial institutions are finding ways to help Muslim families buy a home while avoiding the payment of interest, which their religion prohibits under any circumstances.
This novel approach to financing can also help Orthodox Jews and members of the Hmong community originally from Southeast Asia, who also cannot pay interest. And such financing can extend to loans for other purposes than buying a place to live.
Managing the Cultural Divide
Michigan-based University Bank is one example of an institution that found a way to make financing available without interest payments.
Stephen Ranzini, the bank’s president, said he found some Muslim clients had an interest in buying a home but didn’t feel that they could use a traditional bank.
“When somebody comes in and just challenges a core belief that all banking must include interest, it just blew my mind,” he recalls. “And I'm like, wow, this is really interesting. I mean, I need to learn something more about this.”
Learn he did. And over the past 15 years, working in 16 states, the bank has made some $850 million worth of loans that are acceptable for the Muslim community.
Since 1987, American Finance House LARIBA, a Whittier, CA-based financial institution, has extended the reach of “riba-free” (RF) – or interest-free – financing to all 50 states.
LARIBA and other community shareholders own the full-service, RF Bank of Whittier. The bank provides retail services like checking and savings accounts, and offers non-interest financing, including for purchasing or refinancing a home.
Here is how the riba-free process works:
First, the bank determines whether the value of the property accurately reflects home pricing in the area. Rather than relying on traditional appraisals – which look at sales prices of comparable local homes – LARIBA and the customer collaboratively research prevailing monthly rents for similar properties in the same neighborhood.
While conventional and other Islamic banks use interest as an index to calculate the monthly payment, LARIBA uses comparable rent payments. Rental properties – not money – provide the basis of its finance model. (Traditional Judeo-Christian-Islamic values prohibit renting money via interest.) If the rate of return on investment (ROI) is high, then LARIBA invests in the property and reduces the market rent to make the monthly payment competitive with payment on a loan from another bank. If the ROI is very low, that signifies an overpriced home and LARIBA does not invest in it.
To ensure that the property sale is in the buyer’s interest, LARIBA’s due diligence also includes assessing whether the property is overvalued or undervalued by tracking the prices of certain commodities – such as wheat or gold – against the price of the home.
Should LARIBA and the buyer agree to move forward, LARIBA establishes a lien with the customer that progressively applies rent payments to ownership of the property. The buyer’s monthly rent goes toward repayment of the full cost of the home and the house principal. Over time, the buyer’s percentage of ownership in the property increases, until the buyer finally owns the home outright.
This arrangement satisfies the needs of a buyer who does not want to pay interest, and it can apply to financing for other purposes – such as buying a car or supporting a business.
Fannie Mae is an investor in the property. LARIBA acts as a representative to close the deal, funds it out of its own funds on behalf of Fannie Mae, and then delivers to Fannie Mae for warehousing. LARIBA also can deliver the instrument to an investor – including Fannie Mae – allowing it to support more home purchases.
Dr. Yahia Abdul-Rahman, LARIBA’s founder, started the bank to help increase access to his underserved clientele. “We appeal to people who are sophisticated, educated, first-time homebuyers who want to learn how to invest prudently,” he notes. “Ninety-nine percent of our customers come to us through referrals, and that has been our claim to fame. We do the best we can to offer great personal and family service.”
Leveraging Solutions That Fit the Market
This arrangement suits the conventional secondary market, says Paul Barretto, a product development manager with Fannie Mae.
“Homebuyers are making a down payment as part of a sound financial transaction that aligns with their beliefs,” Barretto says. “There’s no special instrument or documentation needed for Fannie Mae to make it acceptable to the secondary market.”
“The value is their approach. The due diligence they conduct makes certain that the buyer’s income can support the monthly payments, the property itself is a good investment, and the customer understands the responsibilities of homeownership. The riba-free philosophy LARIBA promotes is to live responsibly within your means, which is a universal concept.”
Dr. Abdul-Rahman adds that LARIBA’s and Bank of Whittier’s culturally sensitive approach has enabled the companies to weather the worst of the housing crisis. They have “essentially zero” nonperforming loans and their due diligence – assessing the value of the home based on comparable rental amounts – enables the homeowner to rent the property if they lose their income, he says.
As Barretto notes, “In the end, it’s all about developing creative solutions to increase access to home buying for qualified buyers.”
Adam Korengold is a research analyst with Fannie Mae’s corporate communications team.
(Editor’s Note: This article first appeared in The Home Story, also published by Fannie Mae, on Aug. 1, 2016.)