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How Shari’ah (Islamic) mortgages work

by Ian Henning | Sep 06, 2019
  • A Shari’ah-compliant or Islamic mortgage allows you to buy property without paying interest. While this does not necessarily translate to paying less for your home, it does give you more options when looking to get into the property market. Here’s how they work.
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    Shari’ah mortgage – the basics

    The main difference between a Shari’ah mortgage and a conventional one is that it doesn’t involve paying interest because receipt of interest is prohibited under Islamic law. Lenders who offer Shari’ah-compliant products are also not allowed to finance industries involved in alcohol, gambling and arms. Shari’ah mortgages are not solely for Muslims and are available to everyone.

    How it works

    The bank buys and takes legal ownership of the property you want to purchase. The property is then leased or rented out to you. To purchase the home, you make monthly payments over a fixed term. These monthly payments are a combination of rent and money going towards buying out the bank’s stake in the property.

    See also: It’s a great time to buy your first UK property – here’s why

    Types of Shari’ah mortgages

    There are three kinds of Shari’ah mortgages:

    • Ijara – lease to own
    • Musharakah – joint partnership
    • Murabaha – cost plus profit

    Ijara

    Ijara works by charging the buyer rent instead of interest. The amount you pay every month is usually fixed annually. You can pay off the outstanding balance at any time, without incurring a penalty.

    After you’ve settled on a sale price with the seller, you’ll agree on the mortgage amount with your lender. Your lender will then purchase the property on your behalf. The title deeds of the property will be in the lender's name.

    You will enter into two agreements with your lender. The first is that you will pay back the purchase price of the property in fixed monthly instalments, usually over 25 years. The second is that you will pay an agreed amount of rent each month.

    Your monthly payment decreases each year in line with your gradual repayment of the purchase price of the property. Once you’ve repaid the purchase price, ownership is transferred to you and you no longer need to pay rent.

    You can borrow as much as 90% of the purchase price of the property and repay it until you own the house.

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    Musharakah

    Musharakah is the more popular option offered by lenders. It is a joint partnership between the bank and the buyer. The process of buying an increasing share in the property is called Diminishing Musharakah. This is an arrangement between you and the bank where you both contribute a percentage towards the purchase or refinancing of the property. For example, the bank may contribute 80% and you 20% of the purchase price. If the property is being refinanced, your contribution is the equity in the property.

    There are two types of Diminishing Musharakah: Acquisition and Rent Only.

    Rent Only Diminishing Musharakah

    The bank will lease its share in the property to you for the duration of the finance term and you will make rent-only monthly payments to the bank. During the term of agreement, you will not acquire any shares in the property from the bank – your share in the property will remain constant.

    To acquire a part of the bank’s share in the property during the term, you will either need to pay part lump-sum instalments prior to each rent review and/or make a full lump-sum instalment at any time or at the end of the agreed term.

    You will pay rent for the use of the bank’s share until it has been acquired. Your rent is calculated according to the shares owned. Once you have acquired the bank’s share, whether it’s before or at the end of the agreed term, the bank will transfer full ownership of the property to you.

    Acquisition Diminishing Musharakah

    For the duration of the finance term, the bank will lease its share in the property to you. You will make monthly acquisition instalments through which the bank will sell its share of the property to you. With each acquisition, your share increases, while the bank’s decreases.

    The bank will continue to charge you rent for use of its share of the property while the instalments are being paid. The rent is calculated according to the respective shares owned. Once you have acquired the bank’s share, whether it’s before or at the end of the agreed term, the bank will transfer full ownership of the property to you.

    Murabaha

    This type of mortgage is the least popular option because it requires a large initial amount of capital, and the lending term is generally not more than 15 years.

    The bank buys the property on your behalf and sells it to you for a fixed price. The fixed price will include the price the bank paid for the house and the bank’s profit. For example, you may be looking to buy a house valued at £150,000, but the bank may sell the property to you for £200,000. You will purchase the home in equal instalments over a fixed term.

    To determine the profit amount, the bank will take into consideration the purchase price, the deposit amount, the term of repayment and the market rate of return on real estate transactions for investors.

    See also: The perfect time to secure a better interest rate on your remortgage

    Making a deposit

    You’ll need to pay a deposit of at least 20% of the property’s price to qualify for a Shari’ah-compliant mortgage. For example, if the property you want to buy is valued at £200,000, you’ll have to put down at least £40,000.

    However, depending on your lender, it is possible to secure up to 95% of the property’s value. It’s best to speak to a knowledgeable mortgage advisor who can help you get a mortgage that best suits your circumstances.

    Getting the right mortgage for you

    The mortgage process can seem fairly daunting because of the many steps involved. Our three-step process ensures you get the most appropriate mortgage with the least stress possible.

    It involves an initial assessment of your financial situation, which helps us determine whether you qualify for a mortgage. If your mortgage result is unlikely, we will suggest ways to improve your eligibility.

    Next, we look at factors that impact your mortgage options. These include:

    • The cost impact of putting down more or less deposit and how this may change your mortgage options
    • The impact of costs over time

    Once you know how much you can afford to borrow and how much your home will cost, you can find the right property and make an offer. We will handle your application process all the way through to completion, giving you even less to worry about.

    Choosing the right mortgage is as important as selecting the ideal home. While the mortgage process can be complex, having the right information will ensure you get the most appropriate mortgage for your circumstances. This means understanding the different mortgage options available to you, including Shari’ah and traditional mortgage types.

    We’ve developed professional relationships with the banks and have a specialised understanding of the UK property market. Our mortgage advisors can assist with both Shari’ah-compliant and traditional mortgages. Whether you’re a first-time buyer, remortgaging, purchasing a commercial or buy-to-let property or live outside the UK and want to buy a UK property – we can help.


    Looking to get into the UK property market? Speak to our mortgage advisors to find out how we can help at mortgages@sableinternational.com or call +44 (0) 20 7759 7519.

    We are a professional services company that specialises in cross-border financial and immigration advice and solutions.

    Our teams in the UK, South Africa and Australia can ensure that when you decide to move overseas, invest offshore or expand your business internationally, you’ll do so with the backing of experienced local experts.

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