When it comes to applying for a mortgage, you might think that the biggest decision you make will be between repayment and interest-only. However, there’s another opportunity that you might never have considered – an Islamic mortgage.
What is an Islamic mortgage?
Interest-bearing loans are prohibited under sharia. Conventional mortgages are interest-bearing. In order to overcome this issue, Islamic banks have come up with a product called the “Home Purchase Plan”, or “HPP”. This allows borrowers to buy a house without taking out an interest-bearing loan.
HPP allows a homebuyer to buy a property in partnership with the Islamic bank, while paying rent each month on the portion they do not own. The borrower’s stake in the house increases gradually, over time. In other words, the Islamic bank replaces the “interest” component with “rent”.
Who can apply for an Islamic mortgage?
There is a misconception that Islamic mortgages are only for Muslims. This is not the case – anyone can apply for an Islamic mortgage based on their circumstances and requirements.
In the early days, banks wanted homebuyers to be residents of the UK when applying for a mortgage. The industry has evolved to a level that non-residents may now also apply for UK mortgages, and very often do. This shift also applies to other types of Islamic financing.
Are Islamic banks riskier than conventional banks?
Islamic banks, like other financial institutions, are regulated by the Financial Conduct Authority (FCA) and the Prudential Regulatory Authority (PRA) in the UK. Mortgage intermediaries need special permission from the FCA to advise for Islamic mortgages. It indicates that Islamic mortgages are not riskier than conventional mortgages.
Additionally, the Financial Services Compensation Scheme (FSCS) applies to Islamic banks in the same way it applies to any other UK bank. The FSCS will secure financial instruments a customer has purchased from an Islamic bank in case the bank collapses. Islamic banks do not engage in activities prohibited under sharia, such as derivatives and exotic instruments trading.
No penalty for early repayment
A sizeable proportion of Islamic banking customers are non-Muslims. Borrowers are looking to take advantage of the special characteristics offered by Islamic mortgages. One of the prominent characteristics of Islamic mortgages is that many Home Purchase Plans do not charge a penalty for early repayment.
An Islamic mortgage for buy-to-let (BTL) property purchase
Foreign investors seek property investment opportunities in the UK for several reasons. Islamic mortgages can be a solid method of planning BTL property investments as the mortgage application process is 100% online. Some of the conventional banks have paper-based application methods which are time-consuming and inconvenient.
Different Types of Islamic Mortgage Available in the UK
Diminishing musharakah Islamic mortgage
The diminishing musharakah structure is the most well-known structure in the UK, and if you’re taking out a Home Purchase Plan, you’ll very likely be utilizing this structure. Under this structure, the buyer and the Islamic bank buy the property mutually, with the buyer contributing a deposit and the bank providing the rest. At that point, the buyer gradually repurchases the property from the bank by paying rent on the proportion of the property owned by the bank.
Ijara Islamic home loan
The ijara structure is essentially the same as diminishing musharakah, although with one major difference – the amount the bank contributes to the property purchase is not reduced by the rent paid. For example, say someone purchases a house for £200,000; they put down £40,000 as deposit and the balance of £160,000 is contributed by the bank. Under an ijarah mortgage, you pay rent on the bank’s part of the house every month. However, you do not make any payments towards purchasing the proportion of the property that the bank owns.
Such a home loan is ordinarily not prudent if you are buying a home that you intend to live in, as it forces you to sell the property at the end of the mortgage term to settle the £160,000 due to the bank.
Murabaha Islamic home loan
Under a murabaha structure, the Islamic bank will buy a property on the borrower’s behalf and sell the same property at an increased price afterward. In the UK, murabaha Islamic home loans tend to be associated with buy-to-let property purchases.
What does it mean to me?
Islamic mortgages are flexible and adaptable, and can be utilized for home purchase plans for residential properties as well as BTL investment plans.
Overall, Islamic mortgages are on the rise, specifically due to their unique characteristics. It is the ideal time for foreign investors to plan their property investments in the UK. Consideration of Islamic mortgage opportunities might be an essential element of the planning process.
‘As a mortgage is secured against your home or property, it could be repossessed if you do not keep up the mortgage repayments’