When Does Charging a Penalty Become Haram?

Islamic financial institutions have struggled with whether or not charging a monetary penalty for a late payment is considered a form of interest in Islam. Here’s my answer …

The generous Quran in the Chapter Al-Baqra Verse No:278 – 280 says:

(2:278) O you who believe, fear Allah and give up what remains [due to you] of interest, if you should be believers.

(2:279) And if you do not, then be informed of a war [against you] from Allah and His Messenger. But if you repent, you may have your principal – [thus] you do no wrong, nor are you wronged.

(2:280) And if someone is in hardship, then [let there be] postponement until [a time of] ease. But if you give [from your right as] charity, then it is better for you, if you only knew.

From these three verses and specifically verse 280, it’s clear that in the case of repaying a loan, unless you can prove the absence of hardship on the borrower, no penalties can be charged for a late payment.

The burden of proving the absence of hardship whenever a payment is late doesn’t scale and isn’t compatible with the needs of a for-profit business. But this difficulty doesn’t matter in the case of lending because Islam isn’t concerned with making lending a viable business. Lending in Islam is done strictly as an act of charity.

When it comes to non-lending activities, Islam is (generally) interested in ensuring that these activities can be made into viable businesses and therefore the burden of proving the absence of hardship when charging a late penalty is dropped. A lessor may charge a lessee a penalty if their payments are late just as a utility company may charge a customer for a late payment on an electric bill.

While the title of my blog is practical Islamic finance it seems obligatory that any opinion I articulate must conform with the practical nature of things. If I owe money to someone, whether I’m charged a “penalty” or “interest” makes no difference to me. From this perspective, the function of interest and the function of a monetary penalty seem precisely identical.

However, from the perspective of the party that is owed money I do think there is a substantive difference between interest and penalties; Interest is meant to generate profits whereas penalties are meant to enforce compliance. Accordingly, any penalty that is collected and ends up adding to the profits (or equity) of the company is forbidden. Companies may use proceeds from penalties to cover expenses directly related to collecting these penalties but everything in excess of these expenses must be donated to charity. In this way we ensure penalties don’t become a source of profit for the company and remain distinguishable from interest.

Let’s summarize with a chart:

Monetary Penalties

2 comments

  1. Asalamoalekum. Many thanks for sharing this article. It makes sense however, now a days when majority of the buying is done on credit and late fee comes as a part of the transaction e.g. I buy something on credit and for some reason I delay a payment I get charged for it. Now, living in the UK where lending companies are non Islamic, they won’t follow these principles of donating the excess to charity. I don’t see why any lending company would change their policies for minority population (Muslims are already in minority in the UK and even fraction of that population actually looks at late fee aspect being Haraam). Question is, how can we (Muslims) continue to buy goods on credit when, in any instance a late fee is applied, how would we know whether that amount is going towards their profits or simply covering their expenses.
    In addition to the above; if I buy something on credit which I can easily afford to pay on monthly installments. E.g. a mobile phone which costs me £10 a month. I am able to pay this monthly without any difficulties. One month, due to banks internal issues the payment is delayed and I get charged late fee on it. Based on your article above, I am not in hardship and I can pay the late fee (it will not be considered as Riba) as long the late fee charged is paid towards the lender’s expenses and not their profit. Now, because I don’t know where the late fee money is spent, nor can I request the lender to spend the excess money on charity. As I am able to afford the late fee and not in hardship, how can i still get away with it without knowing where it will be spent.
    My question to get around this situation is that, e.g. based on the above mobile example, I am charged £2 for the late fee (without knowing how much is spent where). As I can easily afford £2, can I pay additional £2 (same amount as late fee) from my pocket to charity to ensure that what I have paid as late fee (which possibly is going to the lenders profit) is balanced out from my money. In total I would have paid £4 (£2 to lender and £2 to the charity) which I can afford without any hardships.

    I have repeated my self on few occasions above, apologies for that. I hope it makes sense what I have posted. I understand your post is from 2015, I look forward to hearing from you shortly.

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    1. Salam Hisham, Thank you for your question, I admire your diligent efforts to abide by Islamic teachings. Regarding the bank and what it does with your late fees, you obviously have no control over that, so the solution is to try as much as possible to avoid incurring such fees. Many banks offer the ability to pay your credit card bills automatically from your checking account when they become due. You may want to consider setting this up. You also only want to buy on credit that which you will have no problem paying off, so that you do not find yourself in hardship when the bill comes due. Additionally, buying on credit in general should only be done for necessary items, not for luxury items that you can do without. For luxury items, save your money and then buy. Finally, in the event that you make a mistake and incur a late fee, I would consider giving an equivalent amount of money to charity only in the event that you can afford to do so and it won’t put you in further financial distress. Since you are not profiting from the late fee you are paying on debt you took out, you can consider doing some other good deed to erase the bad deed of enabling someone to eat riba. Allah says good deeds erase bad ones, and Allah knows best.

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