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Islamic Mortgages Explained

When looking for the right mortgage deal, there are many factors to consider. In a traditional UK mortgage the borrower saves a deposit for a home that is between 10 and 40% of the value of the property they wish to buy. The higher the deposit, the lower the rate of interest charged over the mortgage period, and the less money the borrower will have to pay for their home. Islamic mortgages are different, because under Islamic (Sharia) law it is not permitted to make money by charging interest (riba). This means that Muslims are unable to take out a traditional UK mortgage and in the past decided to rent rather than buy their home.

shutterstock_142816696However, in recent years Islamic banks have started to offer a different type of mortgage, called a Home Purchase Plan (HPP) which enables Muslims (and anyone else) to buy property.

The Different Types of Islamic Mortgage

Just like traditional mortgages, there is more than one type of Islamic mortgage. The differences relate to the relationship between the bank and the homeowner. The first type of loan is called ‘Ijara’, which means ‘lease’ in Arabic. In this type of mortgage, the bank purchases 100% of the property on the homeowner’s behalf and over time the homeowner pays a combination of rent and mortgage payments to the bank. As the years pass the tenant buys a greater proportion of their property. At the end of the agreed mortgage period, assuming all payments are up to date, the homeowner receives the deeds and titles from the bank and is a full homeowner.

A Different Customer Relationship

The second type of Islamic mortgage is called ‘Musharaka’ meaning ‘partnership;’ a different type of relationship compared to the traditional borrower and lender. In this situation, the bank and the homeowner have a shared interest in the property because the homeowner provides a cash deposit (usually a minimum of 20% of the property value). Just as with an ‘Ijara’ mortgage, the homeowner pays the bank a combination of rent and mortgage payments. As time passes, the amount that the homeowner pays is reduced, as they own a greater proportion of their home. Just as with a traditional UK mortgage, at the end of the mortgage period, the homeowner receives the deeds and titles.

The last type of Islamic mortgage is known as ‘Murabaha’, meaning ‘profit,’ and it is less common in the UK. In this situation the bank will buy the property the homeowner wants and then sell it on to them for a higher amount, retaining the difference as profit. From this point on the homeowner pays fixed monthly repayments to the bank based on the price they agreed for the house. Just as before, at the end of the agreed mortgage period the homeowner receives the deeds and titles from the bank becomes a full homeowner.

Islamic Banks do not Charge Interest

In all of these situations the Islamic bank does make a profit from their mortgages, but this is not achieved by charging interest. One of the advantages of this system is that payments made on an Islamic mortgage are based on the value of the home when it was first purchased. This means that in a rising market the bank does not profit from higher house prices, and homeowners are not left struggling to find payments for houses whose value has suddenly risen.

Islamic Mortgage Rates Explained

When you see Islamic mortgages advertised you will find a mortgage rate given as part of the mortgage deal. In the case of Islamic mortgages, it is the mortgage rate determines the rental payment part of the mortgage. In ‘Ijara’ and ‘Musharaka’ mortgages, if there was a 4.49% mortgage rate, this refers to the percentage of the value of the home that is chargeable as rent. So for a home valued at £250,000, the homeowner would pay 4.49% rent on the share that was still owned by the bank (e.g. £748.33 pcm for an 80% mortgage) plus a payment that gives them a greater share of the property.

Calculate Costs Carefully

Unlike traditional UK mortgages, there are usually no penalties for paying your debt early, but there are other administration fees that could mean an Islamic mortgage is more expensive. Currently the Islamic Bank of Britain offers two ‘Musharaka’ mortgages with a 20% deposit: a Discounted Variable rate of 3.99% (base rate plus 3.99%) or a Fixed Rate of 4.19%, both of which are set until June 2016. From January 2016, the margin remains the same (3.99%) but rental charges will be calculated based on the Bank of England base rate.

shutterstock_78771676Both mortgages come with an administration fee of £399 and customers will have to cover the bank’s legal fees over £400. Other banks, such as The Arab Banking Corporation, Ahli United Bank and the United National Bank also offer Islamic mortgages.

Finding the Right Islamic Mortgage

Most Islamic banks do not advertise mortgage rates and so it is important for customers looking for an Islamic mortgage to make individual enquiries and consider factors that are important to them in their individual circumstances, such as how much flexibility they are likely to need, what different fees are charged and whether the property can be rented out. The assessment process for an Islamic mortgage is the same as for a traditional UK mortgage, and if agreed clients can be given the equivalent of a mortgage in principal.

Can I Still Buy to Let?

It is possible to obtain Islamic mortgages for Buy to Let properties, and the Islamic Bank of Britain offer variable mortgage rates of 4.49% with a 35% deposit and 4.89% with a 25% deposit, including the option to pay the rent only and acquire the property at the end of the mortgage period by paying a lump sum.

An Ethical Option

Islamic finance products are not just available to Muslims and can be attractive to customers who are looking for a more ethical bank. One of the reasons for this is because Islamic banks have to operate under strong ethical guidelines that prohibit them from investing in gambling, alcohol, tobacco or pornography.

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