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What is an Islamic mortgage and how do they work?

Updated 07 May 2020

Nick Green
Financial Journalist

Halal mortgages

Islam forbids interest-bearing loans, so Muslims may prefer to seek a halal alternative when purchasing a property. There are a range of Islamic mortgage alternatives available, allowing buyers to get on the property ladder while being sharia-compliant.

What is an Islamic mortgage and how do they work?

Sharia-compliant mortgages are really ‘mortgage alternatives’ and function as no-interest home purchase plans. Though there are several variations across the market, all work in the same basic way: the bank buys the property on your behalf and becomes the legal owner. Your monthly payments function more like rent, with a portion going towards buying out the property owner’s stake. At the end of the term you should either have bought the property back, or have an outstanding sum left to settle before you become the legal owner.

Types of sharia mortgage

The three types of halal mortgage alternatives are:

  • Ijara
  • Diminishing Musharaka
  • Murabaha

Ijara

In an Ijara home purchase plan, you make monthly payments that are part rent and part capital to finance your final purchase. This means your ownership share of the property remains consistent throughout the length of the term.

Diminishing Musharaka

Diminishing Musharaka is a joint purchase agreement between you and your Islamic bank. You pay off the provider’s share in monthly instalments, so your ownership share grows as theirs shrinks.

Murabaha

Under the Murabaha no-interest purchase plan, your sharia-compliant provider buys the property and sells it to you at a marked-up price, which you pay in monthly instalments. These kind of agreements are rarely seen for UK home purchases, but are sometimes used in commercial property development.

As these Islamic mortgage alternatives are all slightly different, you should take care to consider the potential risks and advantages that may come with each, so as to find the right option for you.

What are the risks of an Islamic mortgage?

Although your chosen bank is the legal owner of the property, you will still need to cover the costs of insurance, general maintenance, and conveyancing and stamp duty on the initial purchase. You’ll need to add all of these outgoings to the costs of the purchase plan itself (though of course this warning applies with a conventional mortgage too).  

It is also worth noting that many Islamic mortgage providers will use LIBOR-pegged values to set your rent, rather than using average levels in your local area as a guide. This could work in your favour, but could potentially see you paying more than you would reasonably expect to for your location.

How much deposit do you need for an Islamic mortgage?

You will typically need a minimum of 20 per cent deposit to qualify for a halal mortgage alternative. You will also need to budget for surveys, building insurance, stamp duty and any other costs, such as mortgage broker fees and legal costs.

Being a sharia buyer – where to find your Islamic mortgage

You can find sharia mortgage alternatives at many UK banks and building societies, not just those who specifically describe themselves as Islamic banks. Among the three main types of purchase plan covered here, there are lots of individual no-interest products available, so it’s well worth shopping around for the best deal.

A mortgage broker with experience of this type of mortgage alternative can help you choose between the many different products available. Your broker can also assist you when it comes to remortgaging, which can be complicated with Islamic mortgages (take a look at our full guide to remortgaging for a breakdown of the conventional process).

Islamic mortgages and home purchase plans are regulated by the Financial Conduct Authority, meaning that all providers are legally required to protect your interests.

Find out more about Islamic financial products.

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About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.