Non-Traditional Financing Expands Access in New Markets
Some people are not able to finance the purchase of a home because their religious practices forbid them from paying interest. These include:
- Orthodox Jews who cannot pay interest to, or take interest from, other Jews
- Members of the Hmong community originally from Southeast Asia
- Some Muslim borrowers who cannot pay interest under any circumstances
However, some lenders are finding ways to help them purchase a home without paying interest. This article describes how two financial institutions address the challenge for Muslim homebuyers in ways that could also be used to help other groups.
Managing the Cultural Divide
Stephen Ranzini, president of Michigan-based University Bank, found some Muslim clients didn’t feel that they could use a traditional bank but were still interested in buying a home.
“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.”
During the past 15 years, University Bank has made some $850 million worth of loans in 16 states that are acceptable for the Muslim community.
American Finance House LARIBA, a Whittier, CA-based financial institution, has been involved in financing and refinancing non-interest or “riba free” (RF) faith-based mortgages since 1987. LARIBA and other community shareholders own the full-service RF bank, Bank of Whittier, which provides retail banking services to all 50 states like checking and savings accounts, and offers non-interest financing, including home financing and refinancing.
Here is how the riba-free process works:
First, the bank determines whether the value of the property accurately reflects the value of other home prices in the area. Next, rather than relying on traditional appraisals by comparing other home sale prices (or “comps” in industry parlance), LARIBA and the customer collaboratively research the prevailing monthly rents for similar properties in the same neighborhood.
While conventional and other Islamic banks use interest as an index and calculate the monthly payment, LARIBA uses comparable rent payments. Its finance model is based on renting properties, not money, and renting of money via interest is prohibited by traditional Judeo-Christian-Islamic values. If the rate of return on investment (ROI) is high, then LARIBA invests in the property and reduces the market monthly rent to make the monthly payment competitive with other banks. If the ROI is very low, that signifies an overpriced home (a bubble), and LARIBA does not invest.
To ensure that the property sale is in the buyer’s interest, LARIBA’s due diligence also involves assessing whether the property is over- or undervalued. To this end, LARIBA tracks the prices of certain commodities (such as wheat or gold) against the price of the property.
Should LARIBA and the buyer agree to move forward, they follow a process by which LARIBA establishes a lien with the customer that progressively applies rent payments to ownership of the property. The buyer pays a monthly rent payment that includes the repayment of part of the full cost of the home and a percentage of the rent that reflects the payback of the house principal. Over time, the buyer holds a greater percentage of ownership in the property until, at the end, the buyer fully owns the home.
This arrangement satisfies a buyer who does not want to pay interest and can be applied to other sorts of loans, including to purchase a vehicle or to support a business. Fannie Mae is an investor in the property, and LARIBA acts as a representative to close the deal, fund it from its own funds on behalf of Fannie Mae, and then delivers to Fannie Mae for warehousing. It also means that the instrument can still be delivered to an investor — including Fannie Mae — allowing LARIBA to support more home purchases.
Dr. Yahia Abdul-Rahman, LARIBA’s founder, started the bank to help increase access to his underserved clientele. As he notes, “We appeal to people who are sophisticated, educated, first-time homebuyers who want to learn how to invest prudently…99 percent of customers come to us through referral, and that has been our claim to fame. We do the best we can to offer a great personal and family service.”
Leveraging Solutions That Fit the Market
As Paul Barretto, a product development manager with Fannie Mae, notes, the arrangement suits the conventional secondary market: “Homebuyers are making a down payment as part of a sound financial transaction that aligns with their beliefs. 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 promoted by LARIBA is to live responsibly within your means, which is a universal concept,” Barretto says.
And, adds Dr. Abdul-Rahman, the culturally sensitive approach used by LARIBA and Bank of Whittier has enabled the companies to weather the worst of the housing crisis. Their nonperforming loans are “essentially zero,” 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 homebuying for qualified buyers.”