What is an Islamic mortgage, and how do they work?

The idea of owning a home is deeply rooted in human hopes, and for many people and families, being able to buy a home is an important goal. But traditional mortgage products that are based on interest may not be right for everyone because of religious or moral beliefs. For those seeking an alternative, Islamic mortgages offer a way to finance a home purchase in a manner that complies with Sharia (Islamic law). In this article, we explore the world of Islamic mortgages in the UK, delving into their principles, how they work, and the benefits they offer to homebuyers.

What is an Islamic mortgage?

An Islamic mortgage is a type of home loan that is based on Islamic law, which says that you can’t pay or receive interest (called “riba“).Islamic mortgages don’t use traditional interest-based loans. Instead, they use other ways of financing that are in line with Islamic rules.

Principles of Islamic Mortgages

Islamic finance is based on a set of rules that make sure all transactions are fair and follow Sharia law. The key principles governing Islamic mortgages in the UK are:

Prohibition of Riba (Interest): Sharia law prohibits the charging or paying of interest, which is considered usurious and unjust. Islamic mortgages are structured to avoid interest-based transactions.

Risk Sharing: Both parties in a financial transaction should share the risks and rewards. In an Islamic mortgage, the financial institution and the homebuyer share the risk associated with property ownership.

Asset-Backed Financing: Islamic finance promotes asset-backed transactions, ensuring that each financial transaction is tied to a tangible asset. This principle helps prevent speculative and risky financial practices.

Types of Islamic Mortgages in the UK

There are three primary types of Islamic mortgages available in the UK:

Murabaha (Cost-plus Financing): In a Murabaha mortgage, the financial institution purchases the property on behalf of the homebuyer and then sells it to them at a higher price, which includes a profit margin. The homebuyer then repays the total cost in instalments over an agreed-upon term. In this case, the profit margin replaces the interest charged in conventional mortgages.

Ijara (Leasing): In an Ijara mortgage, the financial institution purchases the property and leases it to the homebuyer for an agreed period. The homebuyer pays rent on the property, with a portion of each payment contributing towards purchasing the property from the financial institution. At the end of the lease term, the homebuyer takes full ownership of the property.

Musharaka Mortgage (Diminishing): This type of mortgage is based on the principle of joint ownership. The customer and the lender both own the property. The customer makes regular payments to the lender to buy out the lender’s share. Once the customer has paid off the lender’s share, they own the property outright.

Regulation and providers

Islamic mortgages in the UK are regulated by the Financial Conduct Authority (FCA), ensuring that they adhere to the same consumer protection standards as conventional mortgages.

Advantages of Islamic mortgages

Islamic mortgages offer several benefits for homebuyers in the UK, including:

Ethical Financing: Islamic mortgages offer a way to finance a home purchase that is in line with Sharia law. This meets the needs of Muslim homebuyers and others who are looking for ethical ways to finance.

Transparency: Islamic mortgages are made to be clear, with no hidden fees or charges and a set profit margin or rental rate.

Financial Stability: By focusing on asset-backed financing and risk sharing, Islamic mortgages promote responsible lending practices and financial stability, reducing the likelihood of financial crises or market bubbles.

Shared risk: In some types of Islamic mortgages, such as Musharaka mortgages, the lender and customer share the risk of owning the property. This can make the lender more willing to lend to customers who may not meet the strict criteria of traditional mortgage providers.

Disadvantages of Islamic mortgages

While Islamic mortgages have some advantages for Muslim customers in the UK, there are also some potential disadvantages to consider:

Higher costs: Islamic mortgages can be more expensive than traditional mortgages. This is because the lender has to structure the product in a way that complies with Shariah law, which can involve additional costs such as legal fees and administrative expenses.

Limited options: The range of Islamic mortgages available in the UK is more limited than traditional mortgages. This means that customers may not be able to find a product that meets their specific needs or offers the same level of flexibility as traditional mortgages.

Limited availability: Not all mortgage providers in the UK offer Islamic mortgages. This can make it more difficult for customers to find a lender that offers the product and may limit their options when it comes to choosing a mortgage.

Complex application process: Islamic mortgages can be more complex to apply for than traditional mortgages. This is because the lender has to ensure that the product complies with Shariah law, which can involve additional paperwork and due diligence.

Limited resale options: In some types of Islamic mortgages, such as Ijara mortgages, the lender retains ownership of the property. This can make it more difficult for customers to sell the property or remortgage in the future.

What fees are involved?

When taking out a mortgage, there are several fees and charges you may encounter. Here is an explanation of the most common fees in simple terms:

Mortgage lender fees: These are fees charged by the mortgage lender to process and administer your mortgage. They may include an application fee, an arrangement fee, a booking fee, and a completion fee. The fees can vary depending on the lender and the specific product you choose.

Legal fees (conveyancing): These fees cover the cost of the legal services needed to finish the mortgage transaction. They may include conveyancing fees, property searches, and Land Registry fees. The fees can vary depending on the complexity of the transaction and the legal services required.

Survey fees: These fees cover the cost of a property valuation and survey, which are necessary to determine the market value and condition of the property you want to buy. The fees can vary depending on the type of survey required and the property value.

Stamp duty (where applicable): This is a tax charged by the government on the purchase of a property. The amount of stamp duty you pay depends on the value of the property and whether you are a first-time buyer.

Buildings insurance: This is insurance that covers the cost of repairing or rebuilding your property in the event of damage or destruction. It is a requirement of most mortgage lenders.

Mortgage broker fees: If you use a mortgage broker to help you find a mortgage, they may charge a fee for their services. The fee can be a fixed fee or a percentage of the mortgage amount.
It’s important to look closely at any fees that come with a mortgage product you’re thinking about getting because they can add to the total cost of the mortgage. You should also talk to a mortgage expert about the product to help you understand the fees and charges that come with it.

Are halal mortgages expensive?

Whether a halal mortgage is more expensive than a traditional mortgage depends on a number of things, such as the specific financing model used, the terms of the contract, and the current market conditions.

In some cases, halal mortgages can be more expensive than conventional mortgages. It is important to compare the overall cost, including profit rates or rental rates, fees, and other charges, to determine which type of mortgage is the best fit for your specific needs and financial situation.

Buy-to-let Islamic mortgages:

A “buy-to-let Islamic mortgage” is a type of home financing that follows Islamic law and is designed for investors who want to buy a property to rent it out to others. Just like other halal mortgages, it avoids interest (riba) by using alternative financing methods that comply with Islamic principles.

Here’s how a buy-to-let Islamic mortgage works:

• An investor wants to buy a property to rent it out.
• The investor approaches an Islamic bank or financial institution that offers buy-to-let Islamic mortgages.
• The bank buys the property on behalf of the investor using one of the Islamic finance models, like Murabaha (cost-plus financing) or Ijarah (leasing).
• The investor then pays back the bank through a series of payments, either by buying the property back in instalments (Murabaha) or by paying rent while gradually buying the property over time (Ijarah).
• Once the investor has fully repaid the bank, they own the property outright.
• Throughout the process, the investor can rent the property to tenants, generating rental income.

The main difference between a buy-to-let Islamic mortgage and a conventional buy-to-let mortgage is the way the financing is structured. In a conventional buy-to-let mortgage, the investor borrows money from the bank and pays interest on the loan. In an Islamic buy-to-let mortgage, the financing is structured in a way that avoids interest, following the principles of Islamic law.

How much deposit do you need for an Islamic mortgage?

The deposit required for an Islamic mortgage, also known as a halal mortgage, in the UK will depend on the lender and the specific product you are applying for. However, as a general guideline, most Islamic mortgage lenders in the UK require a minimum deposit of 10–20% of the property’s value.

This means that if you are looking to purchase a property worth £300,000, you will need to provide a deposit of between £30,000 and £60,000. It’s important to remember that the exact amount of the deposit may change based on your credit score, your income, and the product you’re applying for.

Most Islamic mortgages are set up so that the borrower doesn’t have to pay interest or do other things that are forbidden in Islam. Instead, the lender and the customer agree on a profit margin upfront, which is included in the price of the property. This means that the customer pays back the amount borrowed over a pre-agreed term, which includes the profit margin.

It’s important to remember that the deposit is just one of many things that lenders look at when deciding whether or not to give a mortgage.Customers will also need to meet other eligibility criteria, such as having a good credit score and a stable income.

Will my mortgage comply with Sharia law?

This kind of mortgage is made to be Shariah-compliant, which means it doesn’t include interest payments or other things that Muslims consider haram, or forbidden.

To make sure your mortgage is in line with Sharia law, you should look for a lender that offers Islamic mortgages and read the terms and conditions carefully. It’s also a good idea to seek advice from an expert in Islamic finance to make sure you understand the product and its implications.

If you want to ensure that your mortgage is Shariah-compliant, you should consider getting an Islamic mortgage and make sure you understand the terms and conditions of the product you are considering.

How can I apply for a Sharia mortgage?

If you are interested in applying for a Sharia-compliant mortgage, also known as a halal mortgage, in the UK, here are the general steps you can take:

Research lenders: There are a few lenders in the UK that offer Sharia-compliant mortgages. Research them to find out about their products, eligibility criteria, terms and conditions, fees, and charges.

Check your eligibility: Check the eligibility criteria of the lender to see if you meet their requirements. This may include factors such as your income, credit score, and the amount of deposit you have.

Get an Agreement in Principle (AIP): You can get an AIP from the lender before you apply for a mortgage. This is a preliminary decision from the lender indicating how much you can borrow, based on your financial circumstances.

Gather the documents you’ll need: You’ll need to show the lender things like proof of income, bank statements, your ID, and proof of where you live.

Apply for the mortgage: Once you have all the documents the lender needs, you can send in your application. The lender will assess your application and make a decision.

Complete the purchase: If your application is successful, you will receive a mortgage offer from the lender. Once you accept the offer, the lender will take care of buying the property for you.

In closing

Islamic mortgages provide an ethical and Sharia-compliant alternative to conventional mortgage products in the UK. By adhering to principles that promote transparency, risk sharing, and asset-backed financing, Islamic mortgages offer a viable option for homebuyers seeking a responsible and culturally sensitive financing solution.

It’s important to note that the application process for a Sharia-compliant mortgage may be more complex and time-consuming than a traditional mortgage. Before making a choice, you should talk to someone who knows a lot about Islamic finance.

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