Tim Leonard
Islamic mortgages are designed to allow home buyers to borrow without the need to pay interest, something which is forbidden under Islamic law.
This makes an Islamic mortgage an option for Muslims, and others, who want to raise finance to buy a home while remaining compliant with their beliefs under Sharia law. For this reason, you might also find Islamic mortgages are broadly referred to as Sharia-compliant mortgages and halal mortgages (halal means religiously acceptable according to Muslim law).
Read on to learn more about how Islamic mortgages work and what to consider when looking for a Sharia-compliant mortgage.
Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on a loan or any other debt secured on it.
What is an Islamic mortgage?
In truth, Islamic mortgages shouldn’t be called mortgages at all – they are home purchase plans. Instead of charging interest, as happens with a traditional mortgage, a home purchase plan is essentially a form of sale and lease agreement. The aim, however, is the same: to provide homebuyers with the finance they need to buy a property.
How does an Islamic mortgage work?
Home purchase plans generally involve the bank buying, and initially owning, the property you wish to buy. The monthly payments you make will partly go towards buying the property from the bank and partly be considered rent for allowing you to live there. Once the mortgage term ends, the idea is that you’ll either have repaid the bank’s capital outlay in full, meaning ownership of the property can pass to yourself, or there will be an amount left to pay that needs settling before you can assume ownership.
Types of Islamic mortgage
There are three main types of Sharia-compliant mortgage in the UK:
Ijara
With an Ijara home purchase plan, a Sharia bank buys and becomes the legal owner of the property you’ve found, and leases it to you. You’ll need to make payments that should remain the same each month for a fixed term and will be set to cover your rent, the repayment of some capital, and allow for the bank to make a profit. How much deposit you put down will equate to your share of the property until the end of the term, at which time enough capital should have accumulated to buy out the bank’s stake in the property outright, so you can become the sole legal owner.
Diminishing Musharaka
Diminishing Musharaka works slightly differently to Ijara in that you and the bank are co-owners of the property, and your share will increase gradually as you make repayments. Your deposit will determine the stake you hold initially, but as you gain greater ownership, the rental element of your monthly repayment should start to reduce, because the bank will own less and less of the property. Because of this, Diminishing Musharaka is often considered to be similar to a repayment mortgage.
Murabaha
Murabaha involves the bank buying the property you want and immediately selling it on to you for more than it paid. Your monthly payments shouldn’t change for the duration of the term, and what you owe can be paid off penalty-free at any time. The price you pay for the property will depend on your deposit, the repayment term, and the value of the home.
As you own the property straight away, Murabaha is considered to be a regulated mortgage contract, rather than a home purchase plan (assuming there is a first legal charge over the property). While it might seem the profit a lender makes is against the principles of Islamic law, Murabaha is considered Sharia-compliant because a commodity is being sold for money.
In the UK, Murabaha is most often used to buy commercial property, rather than residential property.
What are the risks of an Islamic mortgage?
Even though you’re not borrowing money, it’s important to understand that you could still lose your home if you fail to keep up with the payments on an Islamic mortgage.
Islamic mortgage providers should be regulated by the Financial Conduct Authority (FCA), offering you valuable protection. Yet situations could still arise which are out of your control but might leave your home at risk. These might include if your provider sells the share that it owns to another party or it goes bust.
Seeking appropriate legal advice when taking out an Islamic mortgage is sensible to try and help protect you from such risks.
How can I check that an Islamic mortgage is Sharia-compliant?
Providers that are offering Islamic mortgages will typically have a panel or committee of Islamic scholars which verifies that their products are compliant with Sharia law. A provider should be willing to share the details of its panel members if you ask, or they might already be available to see on its website.
Is an Islamic mortgage more expensive?
You might find that Islamic mortgages generally are more expensive than other mortgages. This is mainly because of higher administration costs and a lack of real competition among the relatively small pool of lenders that currently offer such plans.
How much deposit do you need for an Islamic mortgage?
A 20% deposit will usually give you a good chance of qualifying for a halal mortgage, but this will vary between lenders and products. It might be possible to find home purchase plans that need as little as a 5% deposit.
What fees will I need to pay?
The types of fees you can expect to pay with a Sharia-compliant mortgage are broadly similar to those you’d see on a traditional mortgage. This means you should budget for:
- survey and valuation fees
- legal fees for two solicitors (one for you, one for the lender)
- stamp duty
- home insurance.
Where can I get an Islamic mortgage in the UK?
There are a handful of banks that currently offer Islamic and halal mortgages to borrowers in the UK.
While there are fewer providers of Islamic mortgages in the UK than for traditional mortgages, it’s anticipated that further Sharia-compliant lenders will enter the market soon.
You should consider using a mortgage adviser for help and support in finding a lender and mortgage that is suitable for you.
Is there a credit check on Islamic mortgages?
Yes, Islamic lenders conduct credit checks before approving halal mortgages to make sure you can afford the repayments on your plan.
Can anyone apply for an Islamic mortgage?
Islamic mortgages are an option for Muslims looking for a Sharia-compliant way to buy property, but non-Muslims can use them too. Often key to their broader appeal is that Islamic banks must operate in line with certain ethical and social responsibilities if they are to abide by Sharia law – meaning they cannot invest in activities such as tobacco, alcohol, arms, gambling and pornography.
Pros and cons of Islamic mortgages
Sharia-compliant mortgages offer some very definite benefits but also come with certain potential drawbacks that borrowers need to be aware of.
Advantages
- You can borrow to buy a home while respecting Islamic law around interest.
- Islamic mortgages are available to Muslims and non-Muslims.
- They offer an ethical way of borrowing.
- Islamic mortgages are regulated by the FCA, so offer the same protection as traditional mortgages.
Drawbacks
- There are fewer Islamic mortgage lenders and plans to choose from.
- They can be more expensive than standard mortgages.
- Islamic mortgages potentially have higher deposit requirements.
- The rent you’re asked to pay could be higher than usual for your area.
Are Islamic mortgages really halal?
Islamic mortgages are considered halal mainly because they don’t involve the use of an interest-based loan.
By the same token, traditional mortgages are widely believed to be haram, or forbidden, under Islamic law, because they necessitate the payment of interest on money.
The banks and other lenders that offer Islamic mortgages will all usually take regular guidance from experts in Islamic law to make sure their plans remain Sharia-compliant.
Are Islamic mortgages regulated?
Providers offering Islamic and halal mortgages should be regulated by the FCA and so abide by its rules. This means the protection you’re afforded with an Islamic mortgage should be similar to that you’d get with any other mortgage covered by FCA regulation.
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