6th October 2023

Your guide to Islamic finance home purchase plans

Buying a home is one of the biggest purchases you'll ever make. However, the traditional mortgage model - where borrowing money involves paying interest - can be a sticking point for those following Islamic principles, which prohibit paying or receiving interest. Islamic finance offers a range of solutions designed to comply with Sharia law, which can facilitate the purchase of a home while avoiding the interest conundrum. This guide will walk you through the basics of Islamic finance home purchase plans, helping you understand your options and make an informed decision.

What Is Islamic Finance?

Islamic finance refers to the means of conducting financial transactions in accordance with Islamic law, or Sharia. In addition to prohibiting interest (Riba), Islamic finance also forbids excessive uncertainty (Gharar) and investing in businesses that engage in activities such as selling alcohol or pork. As a result, this type of finance is deemed halal and suitable for faithful Muslims looking to purchase property.

Why Do People Take Out Islamic Finance Home Purchase Plans?

Choosing an Islamic home purchase plan isn't just a matter of religious compliance; it often reflects a broader lifestyle choice and set of values. Here's why many people opt for Islamic financing options over conventional mortgages:

Religious Compliance

For many Muslims, adhering to the principles laid out in Islamic law is an integral part of daily life, including financial dealings. Islamic home purchase plans offer a way to buy a home without compromising on these religious convictions.

Risk Sharing

Islamic finance models often involve a level of risk sharing between the financial institution and the buyer, such as in the Musharaka plan. This makes the process more equitable and can be more palatable to those who have ethical reservations about the debtor-creditor dynamic in traditional finance.

Ethical and Transparent Transactions

Islamic financial products are designed to be transparent and free from hidden charges or ambiguous terms. For consumers concerned about the fairness and ethics of financial transactions, this is a significant advantage.

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Financial Stability

Some financial experts argue that the risk-sharing models used in Islamic finance create a more stable financial system, less prone to the boom-and-bust cycles experienced in interest-based systems. Those who are wary of the volatility often associated with conventional financial markets may find Islamic home purchase plans to be a safer bet.

Potential for Diverse Investment

Islamic banks use various forms of contracts for home finance, which could potentially be more adaptable to different types of properties and investment strategies. For those looking for more customised options, Islamic finance can provide the flexibility they seek.

Inclusive Financing

While designed to meet the requirements of Sharia law, Islamic home purchase plans are not exclusive to Muslims. Many non-Muslims who are looking for ethical or alternative forms of financing also take advantage of these products.

Alignment with Social Responsibility

Islamic finance also prohibits investment in industries like gambling, alcohol, and those harming the environment. For people concerned about the social and environmental impact of their financial choices, Islamic home purchase plans can offer a more responsible alternative.

How Does Islamic Home Financing Work?

Islamic home financing works by avoiding the use of interest-based loans. It does this by structuring home purchase plans using various contractual forms that comply with Islamic principles. These alternatives create a participatory model, where both parties share risks and rewards, as opposed to the debt-creditor relationship formed in traditional financing. There are a few different types of Islamic home financing, including:

Murabaha (Cost-Plus Financing)

One of the most common Islamic home financing methods is Murabaha. In this arrangement, the bank buys the property and sells it to you at a marked-up price, which can be paid in instalments. The markup is a profit margin agreed upon by both parties in advance, thus avoiding the concept of interest.

Pros:

• Clear and straightforward payment schedule.
• Little ambiguity in terms.

Cons:

• Typically higher initial payments compared to traditional mortgages.
• Less flexibility in repayment.

Ijara (Lease-to-Own)

In an Ijara agreement, the bank purchases the property and leases it to you for a fixed period. At the end of the lease, you have the option to buy the property at a predetermined price. During the leasing period, your payments consist of two parts: a rental fee and a portion that goes toward the eventual purchase of the home.

Pros:

• Lower initial payments.
• Flexibility to walk away at the end of the lease.

Cons:

• You don't own the property until the lease term ends.
• The overall cost may be higher than Murabaha.

Musharaka (Diminishing Partnership)

In Musharaka, you and the financial institution jointly purchase the property. Over time, you buy out the bank's share through regular payments, which also include a rental fee for living in the property. As your ownership stake increases, the rental fee decreases.

Pros:

• Shared ownership reduces individual risk.
• As your ownership stake increases, the rental payment decreases.

Cons:

• More complex arrangement.
• You must manage the partnership throughout the repayment period.

Factors to Consider When Choosing an Islamic Home Purchase Plan

Before choosing an Islamic home purchase plan, it's important to consider which setup is the right option for you. To help you understand this, try to factor in the following considerations when choosing Islamic home purchase plans:

Transparency and Disclosure

Make sure the financial institution provides clear terms and conditions. Transparency in the contractual obligations is essential to ensure that the transaction is genuinely Sharia-compliant.

Flexibility

Assess the flexibility in payment schedules and early repayment options. Some plans may offer more leniency than others, which can be a crucial factor in your long-term financial planning.

Cost Comparison

Though avoiding interest, the total cost of an Islamic home purchase plan might still be comparable to a traditional mortgage. Be sure to understand all costs involved, including administrative fees, to get a complete picture.

Certification and Compliance

Ensure the financial institution has the proper certifications to offer Islamic finance products. The institution should also have a Sharia board to monitor and ensure compliance with Islamic principles.

Find the Right Islamic Home Purchase Plan for You

Islamic home finance provides viable alternatives to traditional mortgage plans, enabling you to buy a home while adhering to Islamic principles. Understanding the various options and carefully considering the pros and cons can guide you toward a decision that aligns with both your financial capabilities and religious beliefs.

If you'd like further guidance around Islamic home purchase plans, or would like to find the most suitable option for your needs, contact our team at WIS Mortgages today.

As a mortgage is secured against your home/property it may be repossessed if you do not keep up with the mortgage repayments.

Frequently Asked Questions

Q. What banks offer Islamic home purchase plans?

A. There are several specialist financial providers that offer Islamic home purchase plans, including some big names like:

• Al Rayan Bank
• Ahli United Bank
• United National Bank
• Gatehouse Bank

Q. Is obtaining an Islamic home purchase plan difficult?

A. When compared to traditional mortgages, Islamic home purchase plans can be harder to qualify for. They tend to require a larger down payment - sometimes up to 25% of the total property price. With that said, if you can find a Sharia compliant plan, you might be able to find a plan that only asks for a 5% deposit.

Q. Can anyone get an Islamic home purchase plan?

A. Yes, as long as you qualify for the plan then you can take it out. It's a financial product available to anyone - including non-Muslims.

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