Islamic Mortgages

What is an Islamic mortgage?

In Islam, money is seen as something that should have no inherent value. The creation of wealth is only permissible when based upon fair trade and making money from money goes against Sharia law. Given that the act of charging interest is literally making money from money, this standard mortgage practice used in traditional mortgage lending is haram for Muslims. 

In order to be compliant with Sharia law, an Islamic mortgage (also referred to as a halal mortgage) is not actually a mortgage at all, it’s a home purchase plan (HPP). This is more of a lease agreement between the lender and the customer, with no interest payable.

The HPP still provides customers with a viable way to purchase their own home, however, it does so in keeping with their faith. 

How do Islamic mortgages work?

With an Islamic halal mortgage, the bank buys the property for you and either charges you rent until you fully own it, or sells it back to you at a higher price.

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.

Just like buying a home with a regular mortgage, you will enter a contract with the seller and agree a price. You will need to provide the Islamic mortgage provider with a deposit (typically 5-35% depending on the lender), and they will use that towards the purchase of your property.

The lender owns the remainder of the property (that wasn’t covered by your deposit) and either charges you monthly instalments in the form of rent or sells the property back to you at a higher price, which you repay at a fixed amount each month. 

The rental rate on an Islamic mortgage can fluctuate, but HPP products usually have an initial fixed period like many standard mortgages. 

What are the different types of Islamic mortgages?

There are three main Sharia compliant mortgages in the UK, with Musharaka (partnership) being the most popular for residential purchase, and Iljara (lease), and Murabaha (profit) also available, but more often used in commercial transactions.

Musharaka

Also known as Diminishing Musharaka, this is a partnership between the home buyer and the lender, where each owns a share of the property. Your monthly repayments are split into part capital and part rent, allowing you to buy more of the bank’s share with every repayment.

A typical term is similar to the length of a mortgage term, at around 25 years. Over this duration, your rent reduces as your share of the property grows, hence the term diminishing, which refers to the bank’s share diminishing over time. Eventually you’ll own the entire property.

This works very similarly to a traditional repayment mortgage, but with the interest replaced with rent, to ensure compliance with Sharia law. 

Murabaha 

This type of Islamic mortgage operates slightly differently, in that instead of charging you rent, the lender buys the property and then sells it back to you at a higher price. You buy your home from them over a fixed term, again, usually around 25 years, in equal instalments.

In this scenario you are classed as the homeowner from the outset, rather than being in a partnership with the lender, so long as you keep up with your monthly repayments. 

In the UK, Murabaha is more commonly used to buy commercial property, such as buy-to-let rentals or business premises, rather than in the purchase of a residential home. In the Middle East and Far East it is more widely used for any type of property purchase, however.

Iljara 

Ilajra, which means lease, is where the bank purchases the property you want to buy and leases it back to you. This works similarly to a traditional interest-only mortgage, although the interest is replaced with the rental cost you pay to lease the property.

For example:

You provide a deposit of £20,000 on a £100,000 property

The lender provides the remaining £80,000 and purchases the property

You pay rent on the lender’s 80% share of the property for a set period of time

At the end of the term you will need to repay the 80% to the lender in order to buy their share and home your home outright

This type of borrowing is not often used for residential purchase, as the majority of buyers would need to resell the property at the end of the lease period in order to repay the loan.

It is often used for the purchase of buy-to-let properties, however, as the monthly repayments will be lower than for a Diminishing Musharaka, given that you are not repaying any of the capital (amount borrowed).

Is my Islamic mortgage Sharia compliant?

Lenders offering Islamic mortgages use the guidance of scholars who are experts in Islamic finance and Sharia law to make sure their products are Sharia compliant.

They also carry out regular reviews in partnership with Islamic scholars to ensure that any changes to the products are assessed and authorised by Sharia law.

Islamic mortgages are regulated by the Financial Conduct Authority (FCA), meaning customers have the same protection and rights as those customers taking out an interest-charging mortgage.

Which banks offer Islamic mortgages?

Islamic Banks created this form of mortgage, however, very few Islamic banks operating in the UK actually offer this form of HPP, including Al Rayan Bank (formerly the Islamic Bank of Britain) which used to offer them, but no longer does.

Unfortunately this can mean that they are more expensive than interest-charging mortgage products, as there is not as much competition in the market. However, there are around five lenders offering sharia mortgages in the UK and a number of other financers looking to move into this market 

What fees will I need to pay with an Islamic mortgage?

There are similar fees involved with an Islamic mortgage as traditional mortgage fees, such as:

• An administration cost - similar to a mortgage arrangement fee but typically cheaper

• Valuation fees

• Legal fees

• Stamp duty