What’s the difference between ‘Traditional Western Mortgage’ and ‘Declining Equity Real Estate Partnership Arrangement’?

Before talking about what is the difference between ‘Traditional Western Mortgage’ and ‘Declining Equity Real Estate Partnership Arrangement’, let’s just get into what exactly these two are so we can continue from there.

Traditional Western Mortgage

In the traditional Western mortgage the interest-rate is the driving factor, the industry rates define the amount of interest that is going to be paid on the principle. Lets look at a few terms that are used in a traditional Western mortgage.

First is the down payment

Second is loaned amount

The third is the interest

So if you get a house for £400,000 and you pay 10% down payment which is £40,000, the remainder of the £360,000 is the loan amount. Assuming that the interest rate on this mortgage is 5% and the mortgage will be paid in 30 years. The monthly payment that is going to be about £1,933. So in total of 30 years the total payments made will be around £695,000 out of which £336,000 will be the interest paid on this home mortgage.

In a traditional mortgage payments are determined based on the interest rate and the annual term. If you change the interest rate the payment will go up or down and if you change the number of years the principle again will change up or down. The problem with this loan mortgage is the bank takes all the rewards and none of the risks.

Declining equity real estate partnership.

This is a term that is used in the islamic banking circles and has been used a lot of muslim halal home mortgage providers. The logic they present is that the loan amount they put up is their portion of the investment in the house.

This seems like a very feasible very reasonable and Islamic method of buying a house which is absolutely correct as long as the following conditions are met:

a. the monthly repayments are not fixed

b. There is no penalty on early termination

c. The rental is not calculated based on interest rates

d. If at any time the mortgage is terminated both the bank and the mortgagee receive equal portions of any gains and losses.

e. There are no late payment surcharges.

f. Rental is calculated based on market rental rates and apportioned according to principal investment in the property.

If the above conditions are met then it is a full form of declining equity real estate partnership method. However, in most cases banks don’t follow these conditions. They usually base their rental income on current interest rates because they are looking for a solid return and are looking for a constant stream of income. Also at the time of termination of the mortgage, if it gets early-terminated, they will recover their own outstanding portion before they will pay out any gains or losses to the mortgagee. Most of this is mentioned in the fine print so people don’t get to read it until they are emotionally vested in the mortgage contract.

Another problem that occurs with the declining equity method based home ownership/partnership as applied by banks is then the repayments are not calculated based on market rental rates. They are in fact calculated based on a fixed interest rate or a variable market interest rate decided at the time of the contract.

As an investment the risks and rewards should be consistently shared between the mortgage and the mortgagee. This principle implies that the rental value of the home should be evaluated after a certain period of time to bring it inline with the current market rental value of the house. An acceptable time duration maybe two years or five years for revaluation of rental amount, which can be agreed between both parties.

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