Guide to Islamic mortgages

An Islamic mortgage, or halal mortgage, enables you to buy a house in compliance with Sharia law. Read on to find out how Islamic mortgages work.

Muslims are banned from earning or paying interest. This makes buying a house with a traditional mortgage pretty tricky.

Islamic mortgages or halal home purchase plans provide a solution compliant with Sharia law. 

What is an Islamic mortgage?

An Islamic mortgage, or ‘home purchase plan’, enables Muslims to buy a home in a Sharia-compliant way.

Sharia is Islam’s legal system, and is followed by Muslims. 

Technically, home purchase plans offered by Islamic banks are not mortgages, but Sharia-compliant ‘mortgage alternatives’.

Do I pay interest on an Islamic mortgage?

Traditional mortgages involve borrowing a sum of money, then repaying the money plus interest

But earning or paying interest (riba) is not allowed under Sharia law. 

Islamic mortgages offer a way to buy a property in instalments but without the buyer paying interest or the bank earning interest. These home purchase plans work on the principle of risk-sharing.

The buyer typically pays rent on a proportion of the property owned by the bank, or the bank buys the property and re-sells it to the buyer at a higher price. Both these options allow the bank to make a profit on the transaction, but not by charging interest.

Is an Islamic mortgage a halal mortgage?

Halal means lawful or permitted in Islamic law – so Islamic home purchase plans are viewed as halal. 

Haram means forbidden by Islamic law. A traditional mortgage would be regarded as haram.

How do Islamic mortgages work?

Islamic mortgages involve buying property in partnership with a bank, rather than borrowing money and repaying it with interest.

There are 3 types of Islamic mortgage.

  • Ijara

  • Musharaka (or diminishing musharaka)

  • Murabaha

Ijara 

An ijara arrangement is usually the most popular and affordable option for British Muslims. This type of home purchase plan is based on the Ijara principle of “lease to own”.

Ijara works like this:

  • you find a house you want to buy and agree a price with the vendor

  • the Islamic bank buys the property on your behalf

  • you pay a deposit (normally a minimum of 10%)

  • you make payments each month, paying a proportion of the purchase price plus an agreed amount of rent

  • terms are normally for 25 years

  • the rent decreases each year as your share of the property grows

  • you can pay off the outstanding balance at any time

  • when you have fully repaid the purchase price, ownership of the property is transferred to you

Musharaka 

A musharaka mortgage is a co-ownership agreement with the bank. You own a share of the property, and the bank owns the other share.  

Musharaka works like this:

  • you find a house you want to buy and agree a price with the vendor

  • the Islamic bank buys the property jointly with you

  • you pay a deposit (normally 5 to 20%)

  • you pay rent on the proportion of the property owned by the bank, plus more shares in the property

  • eventually you will own the bank’s share of the property as well as your own

Murabaha 

With a murabaha arrangement the bank buys the property on your behalf. It then sells the property to you at a higher price. 

This is a less popular option in the UK with only a few lenders offering it.

Murabaha works like this:

  • you find a house you want to buy and agree a price with the vendor

  • the Islamic bank buys the property on your behalf

  • the bank sells the property to you at a higher price 

  • you pay a deposit (normally at least 20%)

  • you repay the remainder of the debt in fixed instalments until you own the property completely

  • terms are normally for a maximum of 15 years

How much will an Islamic mortgage cost?

An Islamic mortgage calculator can give you an indication of what your monthly payments might be on an Islamic mortgage, and the overall cost. 

You will need to input the following information: 

  • the finance amount 

  • the product type 

  • the finance period

What does finance to value mean?

Islamic mortgages come with a maximum ‘finance to value’ or FTV.

The FTV is expressed as a percentage and shows the proportion of a property’s value the bank will help finance. It’s similar to a loan to value (LTV) on a mainstream mortgage. 

A high FTV means you need a smaller deposit, but the “rental rate” is likely to be higher.

A low FTV means you need a larger deposit, but the rental rate is likely to be lower.

What does rental rate mean?

How much your monthly payments will be depends on the “rental rate” on your home purchase plan. The rental rate can be fixed or variable.

Many Islamic banks peg their rental rate to the Bank of England base rate

Will I need to put down a deposit for an Islamic mortgage?

Yes, you’ll need to put down a deposit – this is known as the ‘first payment’. 

For an Ijara plan, it’s normally a minimum of 10% of the property’s value. 

For a Musharaka plan, the deposit can be as little as 5%.

For a Murabaha arrangement, the deposit is normally at least 20% of the property’s purchase price.

The lower the FTV, the higher the deposit or first payment will be. For example, if an Islamic mortgage has an FTV of 60%, you’ll need 40% of the property price for the first payment. 

In general, the lower the FTV, the cheaper the Islamic mortgage as it’s less risky for the bank. 

What other costs are there with an Islamic mortgage?

Although the Islamic bank is the legal owner of a property purchased with an Islamic home purchase plan, you will still be responsible for:

  • stamp duty

  • conveyancing costs

  • surveys

  • legal fees

  • buildings insurance

  • maintenance of your home

Can I take out an Islamic mortgage if I am not a Muslim?

Although Islamic home purchase plans have been created to allow Muslims to buy a home without breaking Islamic law, non-Muslims can also take out an Islamic mortgage. 

You might do this for ethical reasons. Sharia law prohibits Islamic institutions from investing in firms involved with alcohol, tobacco, gambling or pornography. So if you have strong beliefs about these industries, you may prefer to take out an Islamic mortgage.  

Are Islamic mortgages regulated?

Islamic banks are regulated by the Financial Conduct Authority and the Prudential Regulatory Authority, so UK borrowers will be protected in the same way as if you took out a mainstream mortgage.  

You can sell a property purchased on an Islamic mortgage, in the same way you can sell a property purchased with a traditional mortgage.

Do I pay zakat if I have a mortgage?

Zakat is part of the Islamic social welfare system. It requires Muslims with wealth over a certain threshold (nisab) to give 2.5% of their qualifying wealth each year to help Muslims who need it.

It is down to each individual Muslim to work out how much zakat is owed and to arrange the payment.

How do I compare Islamic mortgages and find the best deal?

The following Islamic banks offer UK Islamic mortgages:

  • ABC International Bank

  • Ahli United Bank

  • Al Rayan Bank

  • Gatehouse Bank

  • UBL UK

You should use an Islamic mortgage calculator to compare the total costs of Islamic mortgages offered by these banks. 

A mortgage broker with experience with Islamic mortgages will be able to help you find the best deal.


10th October 2020