Is It Permissible to Sign a Student Loan Agreement That Includes Interest Penalties For Late Repayment?

Question: Can a student sign a contract that stipulates interest on a loan if the student doesn’t pay back their loan on time? They can avoid it if they do indeed payback on time, but interest applies if they are late. This works like a credit card; if you payback the amount you borrowed on time, no interest applies. Thank you.

Summary:

If a loan contract stipulates that an additional payment or interest will be charged in the event of late repayment, then it is not permissible for a Muslim to sign it from the outset. This is because signing the contract constitutes acceptance of and agreement to a prohibited usurious condition, even if the person intends to repay before any interest becomes due. The prohibition is not limited to actually paying interest. Rather, it also includes entering into a usurious contract and committing oneself to its conditions. Accordingly, a contract that contains an interest clause is prohibited. It is not valid to say, “I will repay before any interest is charged, so there is no problem,” because the person has already committed himself to a contract that includes usury in the event of delay.

Answer:

In the name of Allah, all praise is due to Allah, and may peace and blessings be upon the Messenger of Allah ﷺ.

First: The Prohibition of Usury in the Quran and Sunnah

From the Qur'an:

Surah al-Baqarah 2:278–279
“O you who believe! Fear Allah and give up what remains due to you from usury, if you are truly believers. But if you do not, then be informed of a war from Allah and His Messenger.”
Surah al-Baqarah 2:275
Usury is among the gravest of major sins. Allah has declared war against those who engage in it because it leads to the loss of people’s wealth, the unlawful consumption of their rights, estrangement between people, and corruption within societies.

From the Sunnah:

Sahih MuslimAbdullah ibn Masud (may Allah be pleased with him), narrated:
The Messenger of Allah ﷺ cursed the one who consumes usury, the one who pays it, the one who records it, and its two witnesses. When it was said to him, “And the one who writes it and its witnesses?” he replied: “We only relate what we heard.”
This Hadith indicates that assisting in a usurious contract and participating in it is prohibited, even if a person is not the one receiving the interest.
Sahih al-TarghibAbdullah ibn Hanzalah (may Allah be pleased with him) narrated
Prophet ﷺ said: “A dirham of usury that a man knowingly consumes is more severe than thirty-six acts of fornication.”
Explanation: In this Hadith, the Messenger of Allah ﷺ says, “A dirham of usury that a man consumes,” meaning that he takes it or benefits from it. The expression “consumes” is used because spending wealth on food is among the most common forms of benefiting from wealth. Usury has many forms, all of which fall under the broader concept of unlawful increase in financial transactions, whether through lending, buying, or selling. This applies whether the usury consists of excess amounts or deferred payments. The phrase “knowingly” means that the person is aware that it is usury, regardless of whether he earns it for himself or for another. The statement that it is “more severe than thirty-six acts of fornication” may either be intended as emphasis rather than a literal numerical limitation, or it may be understood literally according to a wisdom known to Allah. Usury is more severe than fornication because the usurer effectively attempts to oppose Allah and His Messenger through corrupt reasoning and conduct, which may ultimately lead to an evil end. Fornication is obviously repugnant both rationally and legally and is restrained by factors beyond the law itself. Usury, however, violates the sanctity established by Allah. The Hadith therefore serves as a stern warning against falling into usury.
Sahih al-Jami'Abdullah ibn Masud (may Allah be pleased with him) narrated
that the Prophet ﷺ said: “Usury has seventy-three categories, and the least of them is like a man committing incest with his own mother.”
Explanation: The Prophet ﷺ stated that usury has seventy-three categories, meaning that its sin is divided into many levels. The least severe of these levels is comparable to a man committing incest with his own mother. There is no doubt that this is an enormously grave sin, which demonstrates the severity and danger of usury. The Hadith then continues by indicating that some forms of usury are even more severe than others

Second: Is Signing the Contract Permissible If One Intends to Repay Before Interest Is Charged? The answer is: No. The reality of the contract is that it is a loan conditioned upon the payment of interest in the event of delay. By signing the contract, the person has accepted and committed himself to that condition. For this reason, a number of contemporary scholars have stated that loans containing interest clauses for late payment are prohibited usurious contracts, regardless of whether the delay actually occurs later. The ruling is based upon the nature of the contract itself and the conditions it contains. Third: Can It Be Said That the Interest Is Only a Possibility and May Never Occur? This does not alter the ruling. If someone says: “I am certain that I will repay on time.” The response is that the contract already contains a commitment to a usurious condition in the event of delay. The Shariah does not permit entering into a prohibited contract merely because one expects to avoid some of its consequences. For this reason, the scholars distinguished between: A benevolent loan free of usurious conditions. A loan that contains a usurious condition in the event of delay. The first is permissible. The second is prohibited. Fourth: Comparing It to a Credit Card. This issue is among the most discussed matters by contemporary scholars. Many scholars and Islamic legal councils have ruled that credit cards containing interest penalties for late payment are prohibited because the cardholder agrees to that usurious condition when signing the contract. This remains the case even if the cardholder intends to pay before any interest becomes due. A good intention does not make a corrupt contract valid. Fifth: The Ruling on the Contract Itself. If a contract contains a usurious condition, then that condition is invalid and prohibited. The jurists established the principle: “Every loan that brings a stipulated benefit to the lender is a form of usury.” The increase charged upon late payment is precisely the usury of the pre-Islamic period, when people would say: “Either pay now, or we will increase the amount owed.” Meaning: either settle the debt immediately, or an additional amount will be charged because of the delay. Sixth: The Principle That Whatever Is Built Upon Falsehood Is False Among the well-known legal maxims of the scholars is: “Whatever is built upon falsehood is false.” Therefore, if the contractual commitment itself is founded upon a prohibited usurious condition, then agreeing to it and signing it cannot be considered lawful. For this reason, it cannot be said: “I never actually paid any interest.” Because the issue under discussion is the permissibility of entering into the contract in the first place.

From the Scholars:

Abdul Aziz ibn Baz (may Allah have mercy on him) said:
“If the contract contains a usurious interest clause in the event of delay, then it is not permissible to enter into it.”
Muhammad Nasir al-Din al-Albani (may Allah have mercy on him) said:
“Usurious contracts are not permissible, even if the individual intends to avoid paying the interest.”
Muhammad ibn Salih al-Uthaymeen (may Allah have mercy on him) said:
“Any contract in which a person commits himself to paying usury when its condition is fulfilled is a prohibited contract.”

Final Answer: A loan whose contract stipulates the imposition of interest or an additional financial charge in the event of late repayment is not permissible to sign from the outset. The ruling is not changed by the borrower's intention to repay before any interest becomes due, because what is prohibited is entering into and agreeing to a contract that contains a usurious condition. Accordingly: Signing such a contract is not permissible. Sin is incurred merely by entering into the usurious contract while knowing its true nature. The fact that no interest was ultimately paid does not make the contract valid. The legal maxims: “Whatever is built upon falsehood is false.” and “Whatever is built upon corruption is corrupt.” indicate that contracts founded upon prohibited conditions are not lawful. A Muslim is obligated to seek permissible alternatives that are free from usury and its conditions.

And Allah knows best.

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