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Lending, borrowing and interests is a concept which conflicts with the Islamic principle of equality. Under Sharia principles and laws the receipt or payment of interest is forbidden as it conflicts with the Islamic principle of equality as one party would benefit at the expense of another. There are alternative arrangements available on the market for Muslims seeking a Sharia-compliant way of purchasing a home.
There are a few main types of Islamic mortgages that abide by the Sharia laws called Ijara, Murabaha, Diminishing Musharaka.
We discuss the two methods in this article and find the arrangement that is most suitable for you.
What is Islamic home finance?
In traditional mortgages, the bank will lend a customer money to purchase a property and charge them interest for the loan and take a legal charge over the property.
Muslims face a religious dilemma when seeking to purchase a home as Islam forbids interest bearing loans which is part of conventional mortgages. Islamic home finance can be a way for Muslims to still raise the finance needed to purchase a home without conflicting with their religious principles.
The outcome might be similar to traditional mortgages where you can own your own home but the structure of how this occurs is different. A big difference is under Islamic Home Finance, both the bank and the customer are responsible for the property and act as partners in the property. The bank will hold the legal title of the property and this shares the risks involved with owning a property with the customer hence looking into the well-being of the customer and a joint incentive to look after the property.
With Islamic Home Finance being seen as a joint partnership between the bank and the customer, no penalties will arise should the customer wish to terminate the agreement for reasons such as wanting to move homes. This is not the case with conventional mortgages with a lending and borrowing relationship, where we can expect early repayment charges from the lender as a penalty for paying off the mortgage early.
There are still other costs associated with being a home owner with a Islamic mortgage that need to be considered such as legal fees, stamp duty and insurance.
Islamic Home Finance customers are protected just as conventional mortgages are and still fully regulated.
Ijara home purchase plan is a leasing type of agreement whereby the bank purchases your selected property, retains ownership and the customer makes monthly payments comprising of rent and capital repayment for a fixed term and at an agreed monthly amount.
Until the lender’s stake in the property is bought out at the end of the agreed term, the customer’s share of the property remains constant throughout. Early repayment is an available option and at the end of this lease arrangement the property is transferred to the customer’s ownership.
This lease to own method complies with Sharia principles as rent is seen as a fair exchange for using a property and the rent received is how the bank takes it’s profit. This home financing method could be more expensive in comparison to traditional mortgages which means monthly payments will tend to be higher.
Under Murabaha’s home financing plan, the lender will purchase the property on the customer’s behalf and immediately sells back the property to the customer at a higher price point from which you make an initial lump sum payment followed by monthly payments to the bank until the end of the repayment term.
Right to Buy does not qualify under this arrangement and it is much less popular compared to the Ijara method as the Murabaha arrangement could work out more expensive overall and less flexibility provided to the customer in terms of early repayments.
Another type of Sharia mortgage is called Musharaka which is a co-ownership agreement between the customer and the bank where they buy the property together.
The customer’s ownership grows overtime whilst the bank’s share shrinks as the customer makes monthly repayment consisting of part capital and part rent until eventually the customer owns the bank’s share of the property.
The more of a customer’s stake in the property grows, the less of a share is owned by the bank and this reduces the rent payment for using the bank’s share of the property.
Many UK banks, building societies and lenders on and off the high street provide Sharia mortgages, not just Islamic banks. If you need help and guidance on choosing the between the different products and providers available, please get in touch with us at Needing Advice and we will be delighted to help you.