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How does an Islamic or halal mortgage work?

In Islam it is considered forbidden to borrow or lend money in exchange for interest, which prevents some Muslims from being able to buy a property using a standard mortgage.

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Islamic business lady signing an agreement for an Islamic / halal mortgageHow does an Islamic or halal mortgage work?

However, with an Islamic or halal mortgage, the process is slightly different, allowing customers to get around the rules of interest and still be able to get finance to buy a home.

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What is an Islamic mortgage?

Islamic mortgages, sometimes referred to as halal mortgages, or even home purchase plans, are technically not mortgages at all. Mortgages are loans that are given in exchange for paying interest.

An Islamic mortgage is actually a Sharia-compliant home purchase plan. This means the bank will buy the property for you, and sell it back to you for a higher price or lease it to you at a rate that could fluctuate.

You will have a plan to pay it back in instalments, but there will be no interest involved. Either way, the bank still makes a profit.

In Islam, money is seen as an item that should not have inherent value. The idea that it can accumulate interest and be worth more or less according to outside influences would suggest that it has inherent value in UK society, so under Islamic finance, the banks try to circumnavigate this by taking interest completely out of the equation.

How do Islamic mortgages work?

Just like buying a home with a regular mortgage, you will enter a contract with the seller and agree a price. Your Islamic mortgage provider will then buy the property from the seller. With a standard mortgage, the money would be transferred to you to give to the seller, and you would then be required to pay it back with interest.

With an Islamic mortgage, the bank owns the property and sells it back to you at a higher price. You can still pay this back in instalments just like you would with a standard mortgage, except that you do not pay any interest.

Irrespective of what happens to the Bank of England interest rate, you will not pay any interest on an Islamic mortgage. However, with a leasing or rental agreement on an Islamic mortgage, the rate could fluctuate according to market rental prices.

The process works like this:

  • Find a property, and agree a price with the seller

  • The Islamic mortgage provider will buy the property from the seller

  • The Islamic mortgage provider will sell the property back to you at a higher price

  • You pay back the higher price for the property in instalments

What fees will I need to pay on Islamic mortgage?

There is an admin fee just like on a standard mortgage, however, these are usually much lower. Islamic mortgages generally have fewer fees and charges related to them because they are not really mortgages.

An Islamic home purchase plan means that the bank owns the property, and you will have to buy it from them, rather than pay it back, so generally the process is slightly more straightforward.

However, that doesn't mean that halal mortgages are cheaper. Generally, Islamic mortgages are more expensive and far less competitive than standard mortgages. This is partly because there are so few options on the market for halal mortgages, meaning there is little competition.

Halal financing is generally becoming more mainstream though and according to some, it is simply a matter of time before it becomes just as competitive as a standard mortgage.

Unfortunately, one major cost with an Islamic mortgage and the hire purchase plan process is that you may have to pay for Stamp Duty twice.

Do you have to pay stamp duty twice with an Islamic mortgage?

If the property is over the threshold for paying Stamp Duty Land Tax, then you will have to pay for it twice with an Islamic mortgage.

This is because your bank is buying the home first, and then selling it to you. In both cases, you are responsible for paying the Stamp Duty.

The threshold for paying Stamp Duty is any amount over £125,000. This fee could double if you are buying a home with an Islamic mortgage, so you should factor this in before passing up a traditional financing option from the bank.

Where can you find an Islamic mortgage, UK wide?

Islamic mortgages are in short supply, which is why they are often far more expensive than standard mortgages. The Al Rayan Bank (formerly Islamic Bank of Britain) and UBL UK (United Bank Limited) are the main providers of halal mortgages in the UK.

They provide Sharia-compliant mortgages, as well as other Islamic financial services, including halal savings accounts.

Islamic finance is on the rise, and it's not just aimed at Muslims. Part of the reason why an Islamic mortgage is Sharia-compliant is due to the ethics of the bank. For example, Islamic banks will not use their profits to invest in gambling, alcohol, tobacco or pornography. This is one of the reasons why non-Muslims are also interested in taking out Islamic mortgages.

What does a “good deal” for an Islamic mortgage look like?

One clear benefit to an Islamic mortgage is that the bank is assuming the risk with the customer. This means that regardless of what happens in the economy and to interest rates, the price they charge you will stay the same throughout your agreement to buy it back.

However, if you choose a leasing agreement, and pay rent, the prices could go up or down according to the rental market prices. Islamic mortgage lenders will usually have a fixed rate as an introductory offer on these kinds of agreements. With the added risk, you may end up paying less in the long run, but the traditional home purchase plan is more clear about all of the costs from beginning to end.

Compare your costs with a standard mortgage and see what kind of deal you are getting. Include all of the various setup fees, and see if you are making any savings.

With everything considered, if you are only paying slightly more on your Islamic mortgage than on a standard one, then you are probably getting a good deal.

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Compare mortgages if you're remortgaging, a first-time buyer, looking for a buy-to-let or moving home