Freddie Mac now buys mortgages held by Muslims

By Thomas A. Fogarty, USA TODAY

In a sign of America's changing face, giant mortgage investor Freddie Mac this month started purchasing the home loans of Muslims who follow the Koran's prohibition against paying or collecting interest.

"This is a growth area for us," says Freddie Mac vice president Saber Salam. An estimated 7 million Muslims live in the USA, and their number is growing.

For years, a small number of Islamic financial institutions have structured mortgages to permit observant Muslims to sidestep the interest payments that accompany conventional home financing. But the few institutions making such loans have been hobbled by their limited access to capital.

Freddie Mac's decision to buy so-called Islamic mortgages changes that. A private corporation chartered by the government, Freddie Mac provides financing for about one in six home sales by channeling capital from securities investors to mortgage lenders.

"It really opens us up to all Muslim communities in the U.S.," says Yahia Abdul-Rahman, adviser to American Finance House — LARIBA of Pasadena, Calif., the first Islamic institution to sell its mortgages to Freddie Mac. Abdul-Rahman says Freddie Mac's capital has allowed American Finance, which is offering the mortgages in 15 states, to increase its home loans to about 10 a week, up from about two a month

At the same time, Abdul-Rahman says, required down payments have been halved to 20% and maximum repayment periods tripled to 30 years.

Islamic lenders such as American Finance sidestep interest by entering a partnership with customers to buy a home. The customer acquires the home through a lease-to-own arrangement. Their monthly payment includes two components: repayment of the lender's contribution to the purchase price and fair-market rent.

But the deal also gets translated into the conventional lending documents to conform with U.S. real estate laws aimed at protecting consumers. At that point, the numbers in the Islamic deal are translated into a conventional house deal, interest rate and all.

Because the deal then has what Islamic lenders call "an implied interest rate," observant borrowers have a sum that Abdul-Rahman says may be deducted as mortgage interest for income tax purposes. An IRS spokesman says the agency has never ruled on the legitimacy of such deductions.

Will American Muslims embrace the new option? "If it's available and if it seems to be efficient and transparent, people will probably take it," says Thomas Mullins, director of the Islamic finance program at Harvard.

Freddie Mac's Salam says Islamic mortgages could produce as many as 50,000 home loans totaling $5 billion over 5 years. Freddie Mac plans eventually to pool the loans and sell them to investors as mortgage-backed securities, which company officials expect to have special appeal to institutional investors in Islamic nations.