In Islam, there are other conditions however which are necessary to be met before such an arrangement can be termed as legal in the eyes of the Shariah. Here, we take a look at the conditions surrounding the contract of Ar-Rahn, conditions that make it acceptable as a legal contract in Islam.
First and foremost, the property put up as collateral must have a high liquidity so that it can immediately be converted into hard cash in case of non-payment of the loan by the in debtor, at the agreed date.
Second, the ownership of the collateral does not change even though it remains in the possession of the trustee who acts only as its guardian until the date of payment of his loan. Therefore, should a cost be incurred by the trustee in maintaining the size and shape of the collateral, it has to be borne by the in debtor, i.e. the actual owner of the collateral. Additionally and therefore, any secondary benefits arising out of the collateral are the right and due of the in debtor and the trustee cannot lay claim to any one of them.
Third, the trustee of collateral cannot be held accountable for loss or damage to the collateral if it is proven with solid reasoning before a judge that the trustee was in no way responsible for the loss or damage to the collateral.
Fourth, the ownership of the collateral cannot change until and unless the payment for the loan is made in full or the indebted party approves of such a transaction to take effect.
Fifth, in the event that the in debtor is not able to make due payment of the loan at the agreed on date, a court of law can allow the debt to be settled by selling the collateral in the market. This is allowed even if the asset pledged as collateral is the sole residence of the in debtor, which will in effect be annexed, rendering him homeless. A trustee is however strictly ordered to pay back any balance from the proceeds of the collateral auctioned in the market to the in debtor after his outstanding amount has been settled in full.
Six, for the same reason, although loan against collateral is allowed and legal, an orphan’s property cannot be put up as collateral in Islam under any circumstances whatsoever. This is because there is risk of non-payment by the in debtor for any reason whatsoever. This would imply that the trustee would seek compensation by auctioning the collateral for cash, therefore, effectively snatching away the right of the orphan, although unintentionally.