In this article, we’ll explain how an Islamic mortgage works, which providers offer them and why using the expertise of a specialist broker can help boost your chances of getting one.
What is an Islamic mortgage?
An Islamic mortgage is a halal way of purchasing a property in the U.K. They are considered an alternative to conventional mortgages for Muslims seeking a Sharia-compliant form of finance.
How do they work?
These mortgages are sometimes referred to as a Home Purchase Plan (HPPs). Rather than fitting the classic definition of a mortgage, they’re actually a business partnership between an individual and a bank or lender. There’s a reason for this.
One of the guiding principles of the Islamic faith is that making money from money is forbidden. The creation of wealth is permissible only if based upon fair trade where the risks and rewards can be shared. So, any form of finance which involves a requirement to pay interest on money borrowed – like a traditional mortgage – falls outside the parameters laid down through sharia law.
So, in effect, an Islamic mortgage isn’t a mortgage at all. Rather than lending someone money and charging interest on this amount, a bank will purchase a property on a buyer’s behalf (becoming the legal owner). The buyer agrees to make monthly payments to the lender consisting of capital and rental for a specific term. At the end of the term legal ownership of the property passes over to the buyer.
Islamic mortgages are still considered quite niche with only a select group of lenders (see section below) currently able to provide them. To find out more your best bet is to use a specialist broker who will already have a firm grip on how they work, who offers them and how you can get one that’s fully compliant with Sharia law.
Using our unique advisor-matching service we can introduce you to an appropriate professional, experienced in all forms of Islamic finance who will be able to help you through this process.
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Types of Islamic mortgages
There are three types of Islamic mortgages available in the UK, each offering a slightly different approach:
Diminishing Musharaka (partnership)
Diminishing Musharaka is the most common form of Islamic mortgage, and out of all three types available is the one which sticks closest to the traditional concept of how a Home Purchase Plan (HPP) typically works.
It’s basically a co-ownership agreement between a borrower (you) and a bank where you make a joint purchase, with each owning a share of a property from the outset. Your deposit is your initial share and the remaining share belongs to the bank.
In order to buy the remaining shares, so you can own the property outright, you make monthly payments consisting of rent and capital which are used to purchase the shares owned by the lender over a specific term (usually 25 years, similar to a traditional mortgage).
So, for example, if you want to buy a house for £200,000, with a £40,000 deposit and use this type of Islamic mortgage for the remaining £160,000, your initial share would equate to 20% and the lender owns 80%. Your shares gradually increase and the lender’s diminish as you make more monthly payments (hence, the term ‘diminishing’).
In a nutshell, this type of Islamic mortgage is the Sharia-compliant equivalent of a repayment mortgage.
An Ijara arrangement is based on the principle of ‘lease to own’. Once you find a house you want to buy and have agreed on the price with a vendor, your bank will purchase it on your behalf, becoming the legal owner of the property.
You pay a deposit to the lender (typically anywhere between 10%-20%) and this becomes your share of the property which does not change until full repayment of the outstanding balance is made.
Your monthly repayments consist of two elements – capital and rent. The amount of rent you pay remains constant throughout the term of the agreement. The capital element will accumulate until it is sufficient to pay the outstanding balance.
At the end of the term, when the capital has been fully repaid the legal ownership is transferred over to you. An Ijara arrangement is the Sharia-compliant equivalent of an interest-only mortgage.
This type of Islamic mortgage is most commonly used for purchasing commercial property. A mortgage lender buys the property on your behalf and immediately agrees to sell it to you for a higher price.
Let’s say you find a property with a sale price of £500,000 and want to buy it using the Murabaha method. The lender will buy it for you at this price and sell it to you for, say £600,000 on a deferred payment basis, so you can repay the amount owed over a fixed term but the property will be legally yours from the outset.
The profits made by the lender are seen as acceptable under Sharia law as this is viewed as a fair trade transaction, rather than money being made from money.
All three types of Islamic mortgages are quite different in their approach but all have the same guiding principle, which is to provide a range of alternatives to interest-bearing loans. This is why they’re referred to as mortgage alternatives.
Deciding which option may be right for you can be quite tricky. An experienced Islamic mortgage broker will be able to help fill in all of the blanks so you can make a choice that best suits you. What’s more, they can make sure the deal is fully Sharia-compliant, negotiate with the lender on your behalf and help you with all of the paperwork.
How, and where can you get one?
Currently, in the UK there are four major providers of Islamic mortgages, and the advisors we work with have deep working relationships with them.
The Islamic mortgage market is growing all the time with more and more providers, such as Stride Up and Habib Bank, looking to launch their own suite of products at some point in the near future.
The application process
These are the recommended steps to follow when applying for an Islamic mortgage…
Step One: Do your homework
A good place to start would be to familiarise yourself with the types of Islamic mortgages available and read up on the risks involved. This article has you covered on both of these fronts, but if you’ve already done your research, skip ahead to step two.
Step Two: Get your paperwork ready
You’ll need to produce a range of documents including ID, proof of income, evidence of deposit funds and at least three months’ bank statements. Having this paperwork ready in advance can help save time on your mortgage application.
Step Three: Speak to a broker who specialises in Islamic mortgages:
The more a market grows, the more beneficial it becomes for a consumer as there’s naturally going to be more competition and more choice.
This is where the services of a broker who’s not just experienced in Islamic mortgages but also has a firm understanding of the needs of the Muslim community and sharia law become quite crucial.
If you get in touch we can arrange for a specialist in Islamic finance to speak with you in more detail and provide the specific advice and guidance you’re looking for.
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Deposit, fees and costs
Deposits for Islamic mortgages can vary anywhere from as low as 5% up to 20%, depending on the lender and your specific circumstances. Obviously, the more deposit you can put down, the lower your monthly payments will be and the better your chances of landing a favourable deal.
In addition to your deposit, there are also the following costs you’ll need to budget for, all of which are what you’d expect to find when buying a property:
- Legal fees (both for yourself and for the lender)
- Survey and conveyancing
- Stamp duty (if applicable)
- Buildings and contents insurance
Are these mortgages more expensive?
This really depends on the lender you’ve chosen for your Islamic mortgage and the terms they can offer. It has been known for this type of finance to incur higher administration fees, and require larger deposits than you’d find for conventional mortgages.
An experienced Islamic mortgage broker would be able to highlight those lenders who offer the best terms, whilst incurring lower overall costs. They will also be able to identify any deals where deposit requirements are not so restrictive.
Buy-to-let Islamic mortgages
A buy-to-let property is still considered a lucrative investment and the good news is there are Islamic mortgage providers who offer specific options if you want to pursue this type of opportunity. The market for this is very small, so you’d be limited to just a handful of niche lenders, but the advisors in our network have deep working relationships with them and could negotiate a deal on your behalf.
The deposit required and fees involved will differ depending on the lender you choose. Again, this is where an experienced broker’s advice will be invaluable, saving you both time and money, potentially, by guiding you through the deals currently on offer.
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What are the risks involved?
Despite the fact an Islamic mortgage doesn’t actually involve any borrowing, the risk of repossession still exists if you don’t keep up with your monthly payments.
A lender may be viewed as taking on more of the risk by buying a property on your behalf. In effect, this means they’re allowing you to stay in their property as long as you keep up with the rent payments. If you fall behind, they can take necessary action.
The Islamic mortgage specialists within our network will be able to talk you through the repossession guidelines for all the lenders before you make a decision on which one to opt for.
Get matched with an Islamic mortgage advisor
There’s a lot to think about when you’re searching for an Islamic mortgage, that’s why it’s important to find an advisor who’s experienced in this type of finance and also understands the process of purchasing a property.
This is where we can help. Our free advisor-matching service is designed to pair you with a mortgage broker who will assess your circumstances and requirements so they can be best placed to help you achieve your goals. This will be someone we’ve chosen, based on your specific needs and they’re experience of arranging Sharia-compliant mortgages.
Speak to an expert in Islamic Mortgages
Maximise your chance of approval with a dedicated specialist broker
Yes they certainly are. As with traditional mortgages, islamic mortgages are regulated by the Financial Conduct Authority (FCA). So, you get the same level of protection regardless of which type you choose.
In the U.K, Islamic mortgages are considered halal (permissible under Islamic law). This is due to their status as home purchase plans, rather than interest-bearing loans.
With a traditional mortgage you’re paying interest on the amount you’ve borrowed, therefore, this type of finance would be viewed as haram (forbidden).
No, not at all. Islamic mortgages are available to anyone, Muslims and non-Muslims. If you’re non-Muslim and looking for a more ethical form of finance or simply like the idea of a Home Purchase Plan then you can apply for one.
Every Islamic finance provider uses a panel of scholars who guide them on all matters relating to sharia law and will be able to provide evidence of their approval for these types of products.
Yes they do and these credit checks will follow the same guidance as conventional mortgages as the lender still needs to ensure that you will be able to maintain your monthly payments during the term.
Yes you can. If you opened a Help to Buy ISA account before they closed you can still use the money you’re saving towards a deposit for an Islamic mortgage and this will benefit from a top-up from the government.
For every £200 you save each month, the government adds a further £50 up to a maximum of £3,000.
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