Ijara with Diminishing Musharakah
Ultimately, no matter what financial arrangement is chosen, it should be Shariah-compliant. As Muslims, we are to follow a set of laws in place to guide the events in our lives. In order to be true to Allah and a good human being, we must follow them as much as possible. This means in financial dealings and loans too.
Another type of loan arrangement in home-buying is Ijarah with Diminishing Musharakah. This means that the amount of equity in an asset is reduced with additional capital payments that are made above and beyond the agreed upon payments. As riba is generally seen as forbidden and wrong, we can send additional payments as a thank you or to help the company who offered us a loan.
The equity in an item changes as additional payments are made. This means the financial institution you received a loan from receives less of the equity as you receive more. Ultimately, the asset will be transferred completely to you as the payments are paid back in full in the agreed amount of time set forth in the muslim mortgage agreement. This arrangement complies with the laws of pertaining to Riba.
As you pay additional payments, you buy back an additional share to the home. This helps you with your finances as you only buy little by little instead of all at once. This arrangement works great for someone purchasing their first home or is on a fixed income.
This alternative to a traditional mortgage is under the principle of a Musharakah partnership. However as one owns the property and pays his or her payment's then they will gradually gain full ownership of the property (sometimes in a period of time of 20-30 years).