Contract or aqd is Islamic commercial law means to tie or to bind because the contract is binding between the two parties, the offerer and offeree.

Technically, contract is a legal agreement between two or more persons that creates rights and liabilities.

Contracts are the foundation upon which the Islamic finance product rest.

Contract in Islamic Finance

We have got so many types of contracts in Islamic commercial law like uqud ul muamalat, contracts of considerations, such as contract of bay’, contract of salam, contract of istisna’, contract of ijarah, and so forth.

We have got contracts of donation, al uqud ul tawarruq, like contract of loan, contract of gift, contract of waqf, and so forth.

We have also got authentication contracts, or contracts, al uqud ul tawfiqat like contract of rahm, contract of kafalah, contract of guarantee, and so forth.

In Islamic commercial law for a contract to be binding, there has to be an offer and acceptance between the contracting parties.

Offer and acceptance

Offer is an expression of interest expressed by one of the parties inviting the other the other parties to accept his proposal.

An offer has to be, clear, absolute and communicated to the offeree.

Acceptance is an expression of approving the second party’s proposal with regards to the same specifications and details expressed in the offer.

Both offer and acceptance could be made verbally and in writing.

In Islamic commercial law, for a contract to be valid, it has to be made by free consent of both contracting parties, the free consent of the contracting parties is also known as consensus of both parties without any formal compulsion.

If a contract caused by compulsion, by force, by fraud, that contract is considered void in Islamic commercial law.

And also in Islamic commercial law, for a contract to be valid the subject matter of the contract has to be owned by the seller.

Because the Prophet SAW prevent us from selling something which is not in our disposal.

The contracting parties who conclude the contract must have the legal capacity in order to enter into the contract.

The legal capacity also known as ahliyyah.

The legal capacity refers to the physical poverty to the maturity and soundness of mind of contracting parties who are entering into the contract.

In Islamic commercial law, the subject matter of a contract must be halal and legitimate.

If the subject matter will be haram, like pig meat, like dangerous drug, like alcohol, the contract is considered illegal and haram.

And also the subject matter of a contract must be certain and identified in order to avoid the element of uncertainty.

If you are interested to get us to help you with Islamic finance consultancy and Shariah advisory, feel free to contact us. Our team are looking forward to grow your brand with Shariah compliance products and services.

Islamic mortgage

Home mortgage is a very common terminology describing the way to own and purchase your dream property.

How does it work, conventionally?

You go, simply go to a bank, you don’t have sufficient funds to purchase your dream property, let’s say it’s worth 1 million USD.

You go to the bank, you request a loan facility of 1 million USD, and then once granted from the bank, upon clearance of your credit risk and everything, the Bank will grant you a loan facility of 1 million USD and expect a repayment of that loan facility over a period of time, not just the principal 1 million, but also a certain markup amount which is called interest.

And then, you will use that property to mortgage it to the Bank as a security or as a collateral.

So why is this not permissible under Islamic banking and finance?

It’s mainly because of two main reasons.

One, it’s because the loan facility granted by the conventional bank to you, involves an element of interest. Interest is a very sensitive and a clear prohibition under Islam, which is mentioned in the Quranic verse,

“ وأحل الله البيع وحرم الربا”

Secondly, the loan facility, is not involved in the real economy.

Therefore it does not participate in the real economic risk.

Why is that?

It’s because under conventional loan, the bank is only exposed to the credit risk of the customer.

So let’s say something happens to the customer, he won’t be able to pay the loan, as according to the payment schedule, then the bank will be at loss.

So the bank is only attached to the credit risk of the customer and not to the property itself.

So how does Islamic home mortgage work?

Islamic home mortgage work in various forms.

I will explain to you the 2 most popular way of how you can obtain or how you can purchase and own your dream property under Islamic mortgage facility or product offered by Islamic banking institutions.

Murabahah – Selling and Buying

First, it’s by way of selling and buying.

So, instead of just lending money, similar to the conventional product that I explained to you just now, the Bank acts more like an active trader, so the Bank goes to the seller, and upon the request of the customer, purchases the house, and then immediately after, sells the house to the customer at a mark-up price.

This is a trading activity which is done multiple times and you’ve seen it everywhere in the world and it’s something which is very encouraged in Islam because the main source of wealth in Islam is by way of business – trading business activity.

So, in this structure, in this ”Murabaha” buying and selling structure, the Bank is not just exposed to the credit risk of the customer but the Bank is also exposed to the risk of the asset itself.

So imagine something that happens to the property after the Bank has purchased the property, before selling it back to the customer, then the Bank will be at real risk and real loss.

Ijarah – Leasing contract

Secondly, the option available under Islamic products for Islamic mortgage is by way of a leasing contract or what we commonly term as “Ijarah”.

Ijarah is a literal word under the Arabic language which means lease.

So how does it work?

You go to the bank and request the Bank to purchase the property that you desire and then immediately thereafter, you will lease that property from the Bank.

So now there is a lessor and lessee relationship.

So now, the bank, instead of merely lending money, the Bank acts more actively in the overall transaction.

How?

The bank is being the lessor and customer is being the lessee.

What does it entail?

It entails all the liabilities and responsibilities attached to that property over the leasing period.

So the Bank will be responsible not just to collect the lease payment amount, the bank will also be responsible for the maintenance, for the structural operations of the property until the expiration of the lease tenure.

And then, at the end of the leasing tenure, the Bank will sell that property to the customer at a nominal price, or even the Bank can grant the property to the customer as a gift in which we call as a “hibah” under Islamic contract.