Islamic mortgages – a guide to Ijara and Murabaha mortgages

Discover the range of Sharia-law-compliant property purchase plans available in the UK.

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By

Matthew Boyle

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Islamic law forbids Muslim people to either receive or pay interest. As banks and other lenders typically charge borrowers interest, this previously created a big issue for Muslim people trying to buy homes. Only those that could afford to buy their home without any financial help could do so under Islamic law. Slowly, banks in the UK are beginning to recognise the issue that so many of their Muslim customers face and offer alternative options that don’t deal in interest but in rent instead.

What is an Islamic mortgage?

Islamic or halal mortgages aren’t technically mortgages at all, as borrowing and lending money with interest isn’t allowed under Islamic law. These emerging “halal home purchase plans” or HPPs as they are more commonly known, enable a financial institution to buy a property and then lease it back to you in the form of rent, or they can add a profit to the instalments you pay back rather than interest.Just like conventional mortgages though, Islamic mortgages are regulated by the Financial Conduct Authority (FCA), so this can provide some added protection if you’re unsure how to proceed.

Although created in line with Islamic or Sharia law, it’s not just Muslim people that can choose Islamic mortgages, as non-Muslims may well settle on an Islamic mortgage purely for ethical reasons. As Islamic institutions refuse to invest in firms that are involved with alcohol, tobacco, gambling or pornography, the plans offered may be more appealing than those from other financial institutions.

Currently, these Islamic mortgages come in three different options – Murabuha mortgages, Ijara mortgages and diminishing Musharaka plans.

The differences between Ijara and Murabaha mortgages

What is an Ijara mortgage?

This option is by far the most popular and affordable for British Muslims. The Ijara mortgage does not require the borrower to have vast sums of money to set it up and it is infinitely more flexible. The amount repaid each month is usually fixed annually and any outstanding balance can be paid off at any time, without incurring a penalty.

Ijara mortgages are based on the Ijara principle, meaning “lease to own” and they work like this:

  • Find a house to purchase and agree on a sale price with the seller.
  • Agree to the amount of the mortgage with your Islamic lender who will purchase the property outright.
  • You will then enter into two agreements with the 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.
  • The rent is set annually, and decreases each year in line with your gradual repayment of the purchase price of the property.
  • When the purchase price has been fully repaid to the lender, ownership of the property is fully transferred from the lender to you.

Using this system, you can borrow as much as 90% of the purchase price of the property, and repay it until you own the house, while providing the lender with a profit that is legitimate under Islamic law (Sharia).

What is a Murabaha mortgage?

This option is much less popular in the UK, and very few Islamic lenders offer it. The main reason for this is that a very large initial amount of capital is required by the borrower, and the lending term is typically no more than 15 years, making it difficult to afford for most borrowers. The Murabaha mortgage works like this:

  • Find a property and agree on a purchase price with the seller.
  • The loan amount required is agreed with your Islamic lender.
  • Typically, you will have to provide around a 20% deposit at this time.
  • The lender will then buy the property and immediately resell it to you for a higher price.
  • You will pay back the lender the resale price in fixed instalments until you own the property completely.
  • It is rare for a Murabaha mortgage to extend beyond 15 years, so repayments can be quite high.

The difference between the original purchase price and the higher price at which the property is resold to you provides the Islamic lender with a profit that is compliant with Islamic law.

What other types of Islamic mortgages are available?

Diminishing Musharaka plans

The diminishing Musharaka option means that the financial institution and the customer jointly purchase the property of the customer’s choosing. Under a “musharaka agreement” the customer’s deposit would go towards the purchase price. The customer would then continue to pay rent on the portion of property owned by the financial institution, in addition to buying more shares in the property in order to eventually own it outright. The more rent paid, the greater the portion of property owned by the customer and the less owned by the financial institution.

You might think that charging rent or adding a profit is just the same as charging interest, as the financial institution still makes money. However, there is still a difference to how the money is made compared to conventional mortgages charging interest.

What are the typical deposits, fees and costs?

Traditional mortgage deals all require a deposit to be paid and for the property to be valued before a financial institution agrees to the mortgage. And this is no different for Islamic mortgages.
Murabaha mortgages usually require a bigger deposit of approximately 20% or more of the purchase price, while Ijara mortgages can be offered with a smaller deposit or around 10%.
If you’re considering purchasing a property with an Islamic mortgage, remember to factor in the following costs:

  • Legal fees
  • Administration fees
  • The lender’s valuation fee
  • Stamp duty
  • Buildings insurance
  • Survey

Where can I get an Islamic mortgage?

While the number of Islamic mortgages available in the UK is slowly growing, not all financial institutions offer them. Here’s a list of some of the financial institutions that do:

  • Islamic Bank of Britain
  • United National Bank
  • Ahli United Bank
  • ABC International Bank
  • Al Rayan Bank
  • Barclays Bank
Think carefully before securing debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage.
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