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What Are Halal Loans?

By Lakshmi Sandhana
Updated: May 16, 2024

Halal loans are loans provided by banks that operate according to the Islamic rules of Shariah. These rules, called as Fiqh al-Muamalat, are based the Islamic rules of transactions and promote principles of Islamic economics. Quite a few Islamic banks began to provide alternative financial and banking products in the late 20th century. For customers and commercial Halal companies that want to operate within Islamic percepts, halal loans provide a way around conventional, interest-bearing loans.

Fundamental Islamic banking principles prohibit collecting and paying interest, which is known as riba. The word itself translates as increase, addition, or excess. Under Sharia principles, interest is considered to be compensating in excess without due consideration. Riba can be defined in classic Islamic discourses as surplus value without counterpart. It may also be roughly translated as numerical value was immaterial and ensure equivalency in real value.

The Sharia does not permit accepting or paying interest for loans of money, so halal loans were created as an alternative. They operate in different ways — for instance, when a buyer approaches the bank for a money loan to buy a particular item, the bank may buy it directly from the seller. The bank resells the item to the buyer under strict conditions, which include established collateral. While the bank does sell it to the buyer for a profit, this is not explicit, and no penalties are imposed for late payments. From the very start, the item is registered under the buyer's name, and it may be property or goods.

This type of purchase and deferred payment resale transaction is called Murabaha under Islamic principles. The bank sells the property to the buyer for a fixed, openly stated price in customer-friendly installments. The price factors in both profit and administrative costs. Halal loans thus allow customers to acquire assets without having to opt for traditional interest-based loans.

Ijarah is another approach that is basically a rent-to-own type of transaction. The bank first acquires the property or goods, and the customer leases it until he or she can pay back the full amount over a period of time. Halal loans that work on the Ijarah format can use a contract that allows the buyer to acquire the property after a fixed period of time. Alternatively, they may take the form of basic lease agreements.

There is also a joint venture approach called Musharakah, which translates as sharing. The basic principle involves lending money to businesses, and both entities are responsible for the value of the investment. The profit is made by the sale of stakes at a later date, and both parties agree beforehand to lose or share whatever profit may come. Banks may also issue floating rate interest loans that are based on a rate of return for that company. The bank may suffer a loss under this practice, in accordance to Islamic law, which declares it unjust that the lender profits hugely, leaving only a small portion to the debtor.

A Mudaraba contract is another version of halal loan in which a venture capitalist or financial expert provides the investment. The entrepreneur provides the labor, and any profit or loss are shared by both parties. If the investment is unsuccessful, the bank does not charge a handling fee. It only charges a fee if a profit is made.

SmartCapitalMind is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Discussion Comments
By ddljohn — On Oct 05, 2014

Loans and interest is one area of Islam where most Muslims do not follow Allah's decree. I can't speak for every country, but I know that in many Middle Eastern countries with majority Muslim populations, banks have interest rates. People take loans with interest, they pay them and they also have savings accounts where their money makes interest. Why are Muslims who fast and pray and do everything else, are negligent about this decree, I do not know.

By burcinc — On Oct 05, 2014

@ysmina-- I'm not Muslim but I'm also against the idea of usury. I think that usury is an unfair advantage of lenders and when we're talking about something like student loans, the problem becomes even more apparent.

Considering that millions of Americans now have student loans and half of them are not able to afford their payments, the government needs to seriously consider the interest rates charged on student loans. So I think that loans with interest rates (some student loans have interest rates up to 8%) is not just an issue for American Muslims but all Americans who want to go to go to college for a better future.

I think that if halal loans with 0% interest were made available by financial institutions in the US, non-Muslims would be very interested as well. I wish the government and lenders would for once consider the interest of citizens rather than financial corporations and banks when it comes to lending money.

By ysmina — On Oct 05, 2014

I read a newspaper article recently about British Muslims and how many are unable to go to school because they can't afford it and they can't find student loans without interest. American Muslims have the same issue and I believe there are a few Islamic organizations in both countries that are trying to work on it. There are some scholarships and interest-free halal loans available but they are not enough for the number of Muslim students.

Studying in Western countries and even in Eastern countries where education costs money, is a challenge for Muslims. The worst part is that this is keeping some Muslims from seeking an education beyond high school.

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