What is riba or interest? What are the types of riba? Is riba is limited to a loan contract? Can riba happen in a sale contract?
Riba and Its Types
The word riba means excess, increase, or addition. From a Shariah point of view, it can be interpreted as: an excess compensation or unjustified return in a lending, borrowing, or sale transaction. The most common example is taking a loan from a conventional bank: the bank gives a loan, and the borrower repays the money at a later date with a percentage increase over the original amount.
But riba is not limited to an increase in a loan contract. which is imposed due to deferment of time in payment. The Quran does not specify any particular type of riba. However, Muslim scholars have explained two types of riba based on general texts of the Quran and a number of Ahadith (sayings) of the Prophet Muhammad ﷺ.
There are two types of riba:
- riba in loan contract (Riba al-Nasiyah)
- riba in sale or exchange contract (Riba al-Fadl)
Riba in loan contract (riba al-nasiyah)
This is the commonly understood type of riba. It's an increase in payment from a borrower to a lender over the original loan amount charged by the lender due to delay in time of payment. Note that this type of reba only applies to a loan, not a credit sale (more on this later).
It does not matter whether the increase over the loan amount is fixed at the beginning of the contract, or at the end of the contract if the borrower didn't pay (in the case of default). Any pre-determined or pre-agreed increase, or any extra amount over the original loan amount charged by the lender is considered reba. This could include, for example, if the borrower offered to pay an increase over the loan amount as a condition for repaying the loan because the increase is pre-agreed as a condition of the loan.This type of riba is called riba al-Quran because, the Quran has specificaly prohibited this form of riba as it was commonly practiced in Arab society at that time.
Optional Gift in Repayment Allowed
What if a borrower repays the money, but wants to thank the lender by offering some gift? Is this allowed? Yes!
The key difference here is that an optional gift or increase paid by the borrower must not be pre-agreed and must not be stipulated by the lender. Something coming out of the good will of the borrower to show their gratitude is allowed, and is even recorded in a hadith:
Narrated Jabir bin Abdullah: "I went to the Prophet while he was in the Mosque. After the Prophet told me to pray two Rakat, he repayed me the debt he owed me and gave me an extra amount." [Sahih Bukhari]
Commonplace Examples of Riba al-Quran
Here's a short list of just a few examples you may have heard of. All of these types of products and contracts include reba and are classified as haram or not permissable for Islamic finance:
- Credit cards (note: debit cards are OK)
- Home mortgage
- Car/automotive loan
- Personal loan from a conventional bank
- Bank certificate of deposit ("CD")
- Capital market bonds
- US Government Savings Bonds
Riba in sale contract (riba al-fadl)
This one is not as obvious as riba in a loan. It can happen in a sale or exchange transaction of a commodity. Note that this type of riba only applies to commodities; things like: dates, barley, rice, wheat, oil, sugar, cotton, etc...
If two people exchange the same commodity but in unequal amounts, the extra would be riba. This type of Riba is also called Riba al-Hadith in the literature of scholars because, it is not directly mentioned by the Quran. The Prophet (ﷺ) has classified it as riba in a following hadith:
“Gold for gold, silver for silver, wheat for wheat, barley for barley, date for date, salt for salt, must be equal on both sides and hand to hand, whoever pays more or demands more (on either side) indulges in Riba” [Sahih Muslim].
According to this hadith, there are two main criteria that qualify a sale as having riba:
- Delay in time or deferment of the exchange of commodities
- Difference in quality in exchange of similar commodities
To summarize, when two similar commodities of are exchanged with each other, the following two rules must be observed strictly. Otherwise, the transaction has riba.
Rule of Exchanging Counter Values
- First: the commodities must be exchanged on spot, meaning at the same time. If one of the commodities is delayed, then it becomes Riba. For example, if you give your friend 1 kilogram of dates today, and he gives you 1 kilogram of dates tomorrow, then this transaction is not valid. You should exchange the dates together on the same day.
- Second: the similar commodities must be equal in quantity. For example, if someone exchanges wheat for wheat or salt for salt, it must be equal, for instance, 1 kg for 1 kg. Note that this only applies if you are exchanging the same commodity; this would not apply to exchange wheat for salt. The rules of riba differs when different items are exchanged. The details can be seen in classical books of scholars.
Examples in Practice
If that all seems a bit abstract, let's consider the following examples:
Example 1: Trading Wheat for Wheat
If wheat is exchanged for wheat, then both rules are applied meaning:
- The amount of wheat must be equal in quantity
- The wheat must be exchanged at the same time (on the spot)
Example 2: Trading Wheat for Barley
If wheat is exchanged for barley, then only one rule applies:
- The amounts of wheat and barley can be different; since the commodities are of a different type, the rule of similar quantity does not apply
- The wheat and barley must be exchanged at the same time (on the spot)
Practical Example: Trading Your Old Jewelry
A store offers a service: trade your old gold jewelry for new gold. The store weighs your gold and checks the purity. Your jewelry weighs 12 grams and is of the quality 14k. Based on the weight and purity of your gold, the shopkeeper offers to trade you for 5 grams of 24k gold bullion and they will give you the gold on the spot. Is this transaction halal or does it involve reba?
Answer: this transaction contains riba. Remember: exchanging similar commodities means that both the rule of similar quantity and on the spot transaction apply. The shopkeeper is offering to pay you the gold on the spot - so that is fine. But notice that you are giving 12 grams but only receiving 5 grams. Technically in the shariah, this transaction is not allowed.
To make this transaction halal and remove reba, a better option would be to accept cash for your old jewlerly. Then after you have cash, you can buy whatever you like: any quantity of gold or anything else you like.
How about a credit sales?
A credit sale is when the seller agrees to accept delayed payment for something. For example, if you sell your car to your friend and instead of paying in cash up front, she agrees to pay you every month for 12 months.
When a credit sale is made between the original buyer and seller, it is completely halal and there is no riba.
What if the seller charges more for credit sale?
Suppose your friend offers to sell you her car for $5,000 cash today. But you ask her to sell you the car on creedit, and you will pay her $500 each month for 10 months. Sorry, she says, for a credit sale I would charge $10,000 for the car. Is this OK?
YES! You may be surprised that this transaction is completely permissable in shariah. Why? Because there is NO LOAN invovled here. She is selling her car - and as the owner of the car, she has the lawful right to charge any price she likes. The credit sale is halal whether she charges $1 or $1 million dollars.
A credit sale becomes riba if there is a third party involved providing a loan with interest. For example, when you buy a car from a dealership and they offer you financing. The financing is a loan contract from a bank - not a credit sale with the dealership - and the loan contract has riba. Unfortunately most modern sales for high cost items are structured in this way with a third party providing a loan - and this is riba.
What's the difference?
- In a loan, the item of sale is money; any pre-agreed increase over the original money is riba
- In a credit sale, the item of sale is something (a product, service, item, etc...); the price of the credit sale can be any price the buyer and the seller agree upon, even if it the price for a credit sale is higher - provided the sale is between them and not a third party providing financing