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19th Feb, 2008

Muslim’s Guide to Debt and Money Management Part 6

Intro | Part 1 | Part 2 | Part 3 | Part 4 | Part 5V. Cars, Houses, and ….. oh yes… STUDENT LOANS

So now we have learned insha’Allah how to budget our money, and implemented a strategy to knock out our credit cards and other debts. We have 1k in savings. Now we move to the next steps. Ideally, a person should start focusing on creating an emergency fund – 6 months worth of expenses (not income) set aside for a rainy day.

Most people now after knocking out these major debts, are worried about cars and houses – and let’s not forget student loans. We’ll look at cars and houses first.

One disclaimer before continuing this article. If it has not already become readily apparent, the 3 main sources I am using for my research are:

  1. AMJA
  2. Lectures by Sh. Ghassan Barqawi
  3. Total Money Makeover by David Ramsey

The reason for the first two sources is because from my own personal research in the English language I felt that they provided the best rulings on contemporary finance issues due to not only their Shari’ expertise, but their experience and expertise with the finance system that we live with and deal with on a day to day basis (most specifically in America). In the sources I was able to come across, no one else dealt with these issues in as much depth as they did. As far as the Ramsey book goes, then I elaborated on this in a previous post in this series. It is hands down the best personal finance book I have ever read, and overall the most in tune with the basic principles taught to us in Islam – namely that of avoiding debts and interest.

Car Buying

Car buying in America is a nauseating experience. There’s so many variables and factors, and let’s be honest – there isn’t a single contract out there that’s 100% halal. This includes lease contracts, purchase/finance, etc. As far as car leasing goes, it seems on the outset to be halal since its like a fixed rental agreement. Fiscally speaking though, it’s a really bad contract to get into. Plus, our goal is to be debt free and emancipated from monthly payment slavery. How else are you going to build wealth?

Leasing: I’m not personally sold on leasing as a halal alternative. First of all, they use some type of interest in calculating the amount (which according to some is irrelevant since they quote a fixed price to you). Secondly, the contract itself includes a purchase option at the end of the lease, which according to some scholars is an invalid condition since it’s 2 contracts in one (a sale and a lease). But it does at least seem more lawful than any of the purchase options they have. Conclusion: I wasn’t able to find anything conclusive from any scholar who has analyzed the leasing arrangement offered by automobile dealerships here and given a ruling, if anyone has, please post it.

Buying: There seems to be 2 things here. First, is financing a car purhcase by a third party, whether its your bank or the car company hooking it up through someone. That is definitely money for money, and then money for car. The second one is when the car dealership sells you the car directly at a fixed price (even though they worked interest into the amount). For example, the car dealership says “we sell you this car for $250/month for 60 months” – again same conclusion. If anyone has anything conclusive in the halal/haram sense, please post it.

Now that the halal/haram factor is out of the way (not really since I don’t have any real answers) let’s step back and look at it fiscally now. The best advice I found on this topic was from Dave Ramsey (surprise). His recommendation: Don’t waste money on new cars, they depreciate in value way too quickly. It’s like buying a Lexus, driving out of the dealership and throwing $100 bills out of the window – that’s how quickly your car loses value. A lease is similar, you don’t own it and you are bound by mileage requirements and other conditions.

The best thing to do is find a moderately used car, something reliable and gas efficient, and buy it on cash. Again, big surprise. If you’re driving a clunker, and need a new car, ride it out until you can buy something better on cash. This is where the previous steps come into play of living frugally and putting money into savings, and being free of debts. This is the tool to freeing up cash to be able to do things like put 10k on the table to buy a car on cash. It’s a long process that takes discipline – but then that’s really the big story of money isn’t it? If you buy a car for 1k, and save for a year the $300/month you would put towards a payment, after one year of toughing it out, you can buy a $3600 car on cash. Do it again for another 2 years, and you can upgrade. But all the while – you are financially independent which is the ultimate dream isn’t it? If you lose your job, you don’t have to worry about your car getting repo’ed after 4 weeks if you are behind on the payment.

Also, that monthly payment (the average for American households is about $450/month) can go a long way towards debt reduction or saving. Especially if you are planning to buy a house, thats another easy 25k you can save in 5 years if you have a reliable car you got on cash, such as used Accord or Camry, that lasts during that time.

Ramsey gives an interesting breakdown of leasing in his book. If you rent a car worth $22,000 for 3 years, at the end of the lease it is worth about $10,000. The monthly payment not only covers that depreciation, but also the interest amount built into the payment which gives the car dealership profit. Just covering the loss would be a monthly payment of $333. Plus you have to pay per mile if you go over the allotted amount (usually about 12k miles for one year). On top of this, if the car is not returned in mint condition, the dealership will charge you for excessive wear and tear.

The last statement I will make about cars is that no one disagrees on the fact that the most halal and undisputed way of buying a car is to lay down the cash and buy it straight up. Even if it means getting a used car instead of a new one, but insha’Allah Allah (swt) will put more barakah in that car. Maybe it won’t break down, maybe you won’t get into a car wreck, maybe your car insurance will be cheaper, maybe you will save money on gas and maintenance, and maybe it won’t get totaled or die forcing you to get a new one. All kinds of things can happen that are not in our hands. Insha’Allah if we do our best to have taqwa, Allah (swt) will protect us and our property.

Houses

I’m not going to beat around the bush here. Mortgages are haram according to practically every scholar I have heard discuss this issue. It is straight up money for money. The question arises with Islamic mortgage companies. According to AMJA, the contracts they utilize are not Islamically sound. Some companies are also known to sell off the debt to other corporations like Fannie Mae after taking your contract. Anyone interested can listen to these CD’s – How to Buy a House Islamically by Sh. Ghassan Barqawi. AMJA’s website also has more information on specific companies and their schemes. One thing of note, oftentimes the “shari’ah” endorsements on the websites of these companies are given to a general scheme, and not necessarily to the specific contract the company ends up utilizing, so do not let that mislead you. Most of the contracts used still have interest, but just under different names.

Regarding buying a house through a bank due to necessity, AMJA gave the following ruling,

AMJA asserts that banks’ interest is prohibited riba; therefore, acquiring loans from banks is prohibited except in the case of necessity as defined by Islamic law. This is true whether the acquired loans are for building homes or otherwise. Moreover, necessity should meet the following Islamic prerequisites:

a) In order for necessity to be considered from Islamic perspective it must be a reality not a speculation. This means that a real danger against one’s creed, soul, reasoning ability, offspring, or wealth must already or most probably be in existence. This is the condition that justifies doing what otherwise is prohibited.

b) The danger should be of an urgent nature such as danger of death, or losing a limb or its function if one does not commit what is prohibited.

c) Lacking other lawful alternatives.


AMJA also asserts that general need may take the ruling of necessity in permitting what otherwise is prohibited, provided that the prerequisites of this maxim are met, such as:

a) The materialization of need as defined by Islamic law. Islamic law defines need as the repulsion of harm and physical weakness, which prevents people from taking part in the hustle and bustle of daily life.

b) Lack of other permissible alternatives such that the unlawful covers all areas of the earth and that all means of earning are corrupted, so that the people find no way at all to seek the lawful.

c) To keep within the boundaries of need, otherwise all that relates to comfort and luxury remains prohibited.

d) Inability to move to other places where one can find legitimate alternative.


AMJA’s resolution in this regard explains that the person who cannot afford to buy a home through an interest-free, permissible means should be content with renting.


Renting a residence provides a way out from falling into the riba that is prohibited by Allah and His Messenger. However, if renting becomes extremely hard for some people due to irreconcilable considerations such as the number of family members that exceeds what is allowable in a rented place, an amount of rent that supercedes the family’s financial capacity or any other legitimate urgencies, then, it becomes permissible to use mortgage in light of the aforementioned governing principles.


Nonetheless, this permission can only be used after referring to the people of knowledge, in order to estimate the extension of the need, and to ensure that the prerequisites of necessity-like need are fulfilled. (source)

Now, as far as the contemporary “Islamic Finance” schemes are concerned, the most popular among them is the co-ownership scheme. This is where you buy the house as ‘partners’ and then you pay rent on the portion which you do not own. For a detailed discussion of this contract, listen to the CD set by Sh. Ghassan linked to above. Even a cursory glance at their contract/scheme looks like it is interest with a different name. In fact, I will tell you exactly what happened to me while writing this. I found the declining ownership percentage/payment chart of one of these Islamic companies, and compared it to a mortgage amortization chart. The columns in both are exactly the same. In fact, the only difference is that the words “principle” and “interest” have been changed to “RofC” and “RonC” [Return of Capital (principal), and Return on Capital (interest)]. It also took me less than 5 minutes to take the example chart they Islamic company had on its site, play around with an amortization calculator, and figure out exactly what interest rate they used in the example chart on their site (you might save money going through the bank ;)).

Alhamdulillah though, for Muslims in America it seems there is one company that has gotten the approval of even AMJA, and that is Devon Bank. You can see the relevant fatwa here, and go through the financial section at AMJA’s website for more details.

But of course as has been the theme here, let’s step back and look at it fiscally. If your mind is already made up on buying a house, then from the research above, Devon is the best way to go. And looking at Devon, I would say unless you’re ready to put serious money down – like 25-50% down, then it might be a lot of money to go through them. But then, that should tell us something too. If we can’t afford it – it means we can’t afford it. I hope by now we have learned the 0% down fads are there to help us get into debt by getting things we can’t really afford.

In any case though, buying a house does involve taking a significant amount of debt on your head – we’re talking 6 figure debt. That is not something to take lightly. Especially for something that’s not a necessity when you can rent a nice apartment or even rent a nice house without all the burdens.

 

I was surprised to read in Ramsey’s book that he actually recommends buying a house on cash. I was shocked to hear this. Muslims are so busy trying to run loopholes around the shari’ah to finance houses with interest under another name, that no one is actually preaching the value of saving and buying on cash. It might take a while, sure, but what price can you put on that peace of mind? I know of many people who have purchased houses on cash, and I’m not just talking cheap houses either, but houses close to the half million dollar range. In the Millionaire Mind, they showed that many of the houses bought over a million dollars were actually bought on cash. It’s doable, but it takes some saving and persistence. If saving an amount like 50k or 100k or 150k sounds otherworldly, maybe its a sign that in reality buying a house is not something that you can truly afford to begin with. Besides, what’s wrong with renting a house, or a nice apartment?

One last note on houses. Many people justify buying a house due to the tax break you receive. I will quote something from Ramsey’s book regarding ‘Stupid Tax’:

If your mortgage payment is $900 and the interest portion is $830 [RofC if you are using “Islamic” Finance ;)], you will pay that year around $10,000 in interest. What a great tax deduction! Right? Otherwise, you’d pay $3,000 in taxes on that $10,000. But who in their right mind would choose to trade $10,000 for $3,000?

Student Loans

Again, let’s get the halal and haram of student loans out of the way. Here is the official answer. I can’t give any more than that on whether it is halal or haram. For more you would need to take it to an Imam and go over your specific situation. What I can offer here though insha’Allah, is some advice on the ‘taqwa before fatwa’ and a fiscal look at how the student loans work out.

Dave Ramsey has an excellent discussion on College funding in his book. The most striking quote to me was this zinger,

College degrees do not ensure jobs. College degrees certainly don’t ensure success. College degrees do not ensure wealth. College degrees only prove that someone has successfully passed a series of tests.

No matter how you look at it, at the end of the day, you only get out of your college education what you put into it. Before taking a loan (obviously in the case that you deem it to be permissible due to your situation), consider a few of the following points. Have you put research into what the most cost-efficient college or university to attend is?

Can you save money by going to community college for 2 years and then transferring somewhere else? If you take a loan, is it strictly for education, or is it also – as many people do – financing the college lifestyle of the apartment, food, car, and everything else? Are you going to a public university instead of a private one? Can you live at home and save extra money?

When I went to university, alhamdulillah I was fortunate enough that my parents were able to pay my tuition in cash. However, I should also add that in order for this to happen, I lived at home and commuted almost an hour each way every day. I opted for the local, public university instead of something out of town or a private university. I also worked to help cover some of the expenses. Before taking out a student loan, we should evaluate our situations. Can we work extra to save money for college? The majority of my classmates in college were actually full time employees with families that were going to school part time to complete their degree. Many others worked extra and took less classes per semester in order to pay for tuition. You may not graduate in 4 years flat, however, you can get an education without it being tainted by a student loan. Shaykh Muhammad alShareef had a conference call on finance for AlMaghrib last summer. In it, I remember him clearly telling people that if you cannot afford something like medical school, maybe you are not meant to be a doctor. I thought that was a bitter pill to swallow, but it is an important one. The education we get in college is what we use to seek out our jobs in order to support ourselves and our families. Are we willing to have the entire root of that tainted with ribaa?

Going to college in a manner described above is not only practical, but done by thousands upon thousands upon thousands of people every year. What occupation are you going into? Is the actual college you graduate from really that important? Many big corporations do not even require a degree as long as you have relevant work experience. In fact, it is often difficult to find people in the corporate world who are actually even working in their field of study, much less actually applying the education they got. In high school it seems like the college you go to is the end all be all deciding factor of your future so it is sometimes hard to look ahead. For most subjects though, it is not that big of a gap. Do you think the Calculus or History textbooks at your local community college are going to be that different from ones at MIT or Berkley? The education you receive more often that not is a result of exactly how much work you put into it irrelevant of where you are actually going.

Another option is to get a full time job with a company and then have them pay for your schooling. I know many people who were working full time and having their company sponsor even their Bachelor’s degrees, not to mention graduate degrees.

In Ramsey’s book he also mentions that many options of financial aid are often overlooked. If you take out the time to hunt down scholarships, you can get some, even small ones. I remember receiving a scholarship for almost half a semester’s tuition for simply writing an essay that took about 20-30 minutes. You have to seek it out. When there is a will, there is a way. Above all though, if you are serious about college and need help paying for it, make du’a to Allah (swt), and of course, before selecting any degree or college make Istikharah insha’Allah.

Insha’Allah this will conclude the debt series for now. I know I left out a big section on ‘wealth building’ and retirement/stocks, however, I have been unable to make any significant strides in researching those issues. Hope you enjoyed the series and I look forward to your comments )

 

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