Written by Sadaf Mahsa Khan Malik
Islamic or Sharia law is a set of principles derived from the Qur'an, the holy book of the Muslim faith. With Interest being forbidden under Sharia Law for the Muslim Community, the concept of purchasing a home has been mere impossible for people that were unable to afford to pay for a property in cash. Therefore, many people have settled for renting and never managed to get onto the property ladder, unless they were super wealthy. In 2002, the concept of Sharia Compliant Finance was introduced which enabled the Muslim community to be able to purchase a home by bypassing the charge of interest.
Sharia Compliant Finance is also referred to as Islamic Mortgage, Islamic Finance, Home Purchase Plan (HPP) and Halal Mortgage. Although the names differ, they are all the same. In addition to not charging interest, Sharia Compliant Finance must comply with various other aspects of the Sharia Law such as the money used by the bank to purchase the property must come from activities deemed permissible by Islamic Standards and not come from financing companies involved with alcohol, gambling or non halal meat.
CONVENTIONAL MORTGAGE VS SHARIA COMPLIANT
The basic difference between a Sharia-compliant mortgage and a conventional mortgage is the relationship between the buyer and the lender. With a Conventional Mortgage, a buyer will be asked to put down a deposit for a property and then take out a mortgage for the difference between the purchase price and the deposit. In doing so, the bank will allow the buyer to put their name on the title deed and own the property and put themselves as holding interest of the property for lending the finance to the buyer. When lending the bank will charge an interest rate to the buyer over the term of the mortgage. An example being, you buy a house for £100,000 and put down 20% deposit i.e. £20,000, the bank will lend you 80% of the property value i.e. £80,000. You would then have to pay £80,000 back as capital plus interest which is the interest rate the bank will charge on the product. This would be referred to as a repayment mortgage.
With a Shariah compliant home purchase plan, you buy the property jointly with the bank. Your deposit is your stake, the bank holds the remaining stake, and the property is registered in the banks name. You only hold an interest in the property. The Sharia Compliant Bank instructs a solicitor, who works alongside yours during the purchase process. Your monthly payment is made up of either rent if you have a rent-only agreement or rent and acquisition if you have an acquisition and rent agreement. Rental rates are calculated to reflect the shares you and the bank own in the property.
Types of Islamic Finance
With Islamic Finance, you normally have a partnership together, and this is based on a no-interest basis. There are three types of Sharia Compliant Finance: Ijara (Lease), Musharaka (Partnership) and Murabaha (Profit).
Ijara: this is when the bank purchases the property you want to buy and leases it to you for a fixed term, at an agreed monthly cost charging you a rental rate. When the term is over, full ownership of the property will be transferred to you.
Musharaka: is a co-ownership agreement, where you and the bank own a separate share of the property. Each time you make a repayment, which is part capital and part rent, you buy more of the bank’s share. Consequently, your rent reduces as your share grows and, eventually, you’ll own the bank’s share of the property.
Murabaha: this is when the bank buys the property on your behalf. They then sell the property to you at a higher price. The higher price is repaid by you in equal instalments over a fixed term. 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.
What Islamic Finance is used in the UK?
The most common form of Islamic Finance in the UK is Diminishing Musharaka. This is where Both the customer and the bank contribute a percentage towards the purchase or refinance of a residential property. The bank then leases its share in the property to the customer for the duration of the finance term. Over the finance term, the customer makes monthly acquisition instalments – this is how the bank will sell its share of the property to the customer. With each acquisition instalment, the bank’s share in the property diminishes while the customer’s share increases. While the acquisition instalments are being made, the bank charges the customer rent for the use of the bank’s share of the property, calculated according to the respective shares owned. After the customer acquires the bank’s entire share, either at the end of the agreed term or in an early purchase, the bank transfers registered ownership of the property to the customer.
Types of Repayment
Acquisition and Rent product - This is the Shariah compliant alternative to a conventional repayment (capital & interest) mortgage. Over the agreed finance term, you make a monthly payment consisting of a rental payment (for use of our share of the property) and an acquisition payments (to increase your share in the property). With each acquisition payment, your share increases, and ours diminishes. The makeup of your monthly payment changes over time. When finance providers’ share of the property gets smaller, so does the rental portion of your payment, so more and more of the monthly payment goes towards the acquisition of our share. When all the payments are made, the property transfers into your name.
Rent Only product - This is the Shariah compliant alternative to a conventional interest-only mortgage. Over the agreed finance term, you make monthly rental payments (for use of our share of the property), but no acquisition payments, so your share doesn’t go up just by making your monthly payments. You undertake to acquire our share of the property at the end of the finance term. If you have a rent-only product, it’s your responsibility to look after any financial arrangements that you expect will provide a lump sum big enough for you to buy our share at the end of the product. When our entire share is acquired, the property transfers into your name with both types of products, you can sell the property at any time, just like you can with a conventional mortgage. There are no early payment charges, but there is an account settlement fee. When you sell, you only have to pay the original cost of the property contributed by the bank, less any acquisition payments you may have made. Any increase in the property value benefits you, not us, but just like with a conventional mortgage, a decrease in value also affects you.
Why are Rental Rates Higher?
It is likely for Sharia Compliant Finance you will have to put down a bigger deposit compared to a conventional Mortgage. Although, this can vary from provider to provider but it is typically 20% of the Purchase value. Also, rental rates can be more expensive because Sharia Compliant Finance has to cover administration costs.
How we do we proceed?
Levena Finance works with a variety of providers to find you the best product suitable to your needs. All Islamic Finance/Home Purchase Plans are regulated by the Financial Conduct Authority (FCA), so customers will get the same protection as they would, had they taken out an interest-charging mortgage. If you give us a call on: 0203 289 4981 to discuss your needs. Islamic Finance is not restricted to just the Muslim Community as a fair share of borrowers are Non-Muslim.
YOUR HOME MAY BE AT RISK IF YOU DO NOT KEEP UP THE PAYMENTS ON YOUR HOME PURCHASE PLAN.