Islamic Mortgage:
Are you a devout Muslim who wants home loan complying with Sharia principles? Then Islamic home finance (it is not really a mortgage!) may be for you. Or you may be a non-Muslim who likes the principle behind Islamic finance. In either case you can avail Islamic home finance from certain banks in the UK (e.g. Islamic Bank of Britain (IBB) or HSBC). As Sharia does not recognize time value of money, the key factor here is that there is no concept of principal and interest, it is replaced by “rent” which you pay to the bank for privilege of owning the property.
In practice this means:
You agree price with the seller and approach the bank for finance (same as traditional mortgage)
The bank buys the property from the seller and sells to you at a higher price. You pay it back in equal monthly instalments over the agreed term. This monthly instalment is termed as “rent” although there is no landlord-tenant relationship.
Your stake in the property is equivalent to money you have paid back so you begin with initial stake equivalent to deposit and then it goes on increasing as you pay back each month. At end of the term the property will be 100% yours just like in traditional mortgage.
The price mark-up is completely discretionary. In reality the bank is likely to set it in line with the interest rate for traditional mortgage. E.g. if you are requesting loan of 350,000 and the interest rate is 4.25% and term 25 years then total sum payable will be 568,825.01 on repayment basis with the monthly payment of 1896.08. Therefore the bank may set the price at 568,825.08 keeping the monthly rent at 1896.08. However the price is calculated considering various risk factors and using the actuarial basis so it is similar to pricing of insurance. As such it is difficult to compare against the conventional mortgage. There is no obligation on them to be guided by the interest rate.
If you are considering Islamic finance then you must consider the following points carefully and discuss in detail with your lender of independent financial advisor.
Whilst there is no traditional interest payment, this is by no means free money. In fact, you may find that Islamic finance deal is more expensive than traditional mortgages. The bank will make their profit mainly through the higher price they set for you.
The initial transaction consists of 2 sales (from seller to bank and bank to you) so you must consider stamp duty implications carefully. In traditional mortgage there is only one sale.
Wherever tax relief is available on interest payment (in the UK it is available on Buy to Let mortgages but not on residential mortgages) you may not qualify for it as technically there is no interest.
Whilst the risk of repossession in case you fail to pay is perhaps no more than that in traditional mortgage, if you fall in arrears, you may have to fork out more in charges compared to traditional mortgage. In the UK, for traditional mortgages there are FCA mandated rules on how to treat the customers in arrears whereas here the bank has much more discretion and the level of protection from the regulator may not be as robust as that for traditional mortgage holders.
Given all these complications, the best is to check with the lender thoroughly about these things and obtain independent financial advice before taking out Islamic finance.
Disclaimer: The information and advice mentioned here is of general nature only and should not be construed as financial advice. The author is not liable for any loss or damage suffered because of this advice.