Islamic Mortgage 2021 – How Does It Work?

What Is an Islamic Mortgage

What Is an Islamic Mortgage and How Does It Work?

An Islamic mortgage, or ‘home purchase plan’, enables Muslims to buy a home in a Sharia-compliant way. Sharia is Islam’s legal system, and is followed by Muslims. Technically, home purchase plans offered by Islamic banks are not mortgages, but Sharia-compliant ‘mortgage alternatives’.

According to Islamic law, Sharia, the Muslims are forbidden to pay or receive interest. Most of the mortgage products on the market thus were unsuitable for Muslim borrowers as this Islamic mortgage is mainly based on interest.

As a result of the increasing demand by Muslim borrowers, lenders have in recent years expanded their product ranges with Sharia-compliant mortgages.

Under Sharia law, two mortgage types are available to potential homeowners: Ijara (Lease To Own) and Murabaha (Deferred Sale Finance) loans.

The Ijara Loan

By this method, the mortgage lender would buy the property from the vendor; becoming the owner. The lender then leases the property to the over 20 to 25 years with a monthly lease payment. The lease payments would take all of the lender’s costs into account.

An Ijara arrangement is usually the most popular and affordable option for British Muslims. This type of home purchase plan is based on the Ijara principle of “lease to own”.

Ijara works like this:

  • you find a house you want to buy and agree on a price with the vendor
  • the Islamic bank buys the property on your behalf
  • you pay a deposit (normally a minimum of 10%)
  • you make payments each month, paying a proportion of the purchase price plus an agreed amount of rent
  • terms are normally for 25 years
  • the rent decreases each year as your share of the property grows
  • you can pay off the outstanding balance at any time
  • when you have fully repaid the purchase price, ownership of the property is transferred to you

Now the Muslim borrower’s payment would now be treated as rent instead of “interest”. And the payments would fluctuate with the interest rate changes.

The lease agreement would also specify that the occupier can buy the property from the lender for a very small sum, usually £1, at the end of the lease period.

The Murabaha Loan

By the Murabaha method, the mortgage lender purchases the property and immediately resells it to the Muslim borrower at a higher price.

The profit that the lender essentially makes out of this transaction is the equivalent of all the interest on a fixed interest loan as well as any costs incurred.

The borrower then buys the property from the lender at that gross figure, which is then repaid to the lender in equal installments for a period, typically of 15 to 20 years.

Murabaha works like this:

  • you find a house you want to buy and agree on a price with the vendor
  • the Islamic bank buys the property on your behalf
  • the bank sells the property to you at a higher price 
  • you pay a deposit (normally at least 20%)
  • you repay the remainder of the debt in fixed installments until you own the property completely
  • terms are normally for a maximum of 15 years

Musharaka 

A musharaka mortgage is a co-ownership agreement with the bank. You own a share of the property, and the bank owns the other share.  

Musharaka works like this:

  • you find a house you want to buy and agree with a price with the vendor
  • the Islamic bank buys the property jointly with you
  • you pay a deposit (normally 5 to 20%)
  • you pay rent on the proportion of the property owned by the bank, plus more shares in the property
  • eventually, you will own the bank’s share of the property as well as your own

An Islamic mortgage calculator can give you an indication of what your monthly payments might be on an Islamic mortgage, and the overall cost. 

You will need to input the following information: 

  • the finance amount 
  • the product type 
  • the finance period

Can I take out an Islamic mortgage if I am not a Muslim?

Although Islamic home purchase plans have been created to allow Muslims to buy a home without breaking Islamic law, non-Muslims can also take out an Islamic mortgage. 

You might do this for ethical reasons. Sharia law prohibits Islamic institutions from investing in firms involved with alcohol, tobacco, gambling or pornography. So if you have strong beliefs about these industries, you may prefer to take out an Islamic mortgage.  

Although the Islamic bank is the legal owner of a property purchased with an Islamic home purchase plan, you will still be responsible for:

  1. stamp duty
  2. conveyancing costs
  3. surveys
  4. legal fees
  5. buildings insurance
  6. maintenance of your home

Read Also: How To Move Out Of Your Parents House

Islamic Mortgage 2021 – How Does It Work?

Islamic or halal home purchase plans are popular because borrowing and lending money in exchange for interest is forbidden under Sharia law. This means that mainstream mortgages are not appropriate for Muslims, who have previously struggled to find ways to get a foot on the property ladder.

Under the Sharia law of Islam, the payment or receipt of riba (also known as interest) is prohibited, and thus a conventional mortgage that charges interest each month cannot be utilized by a practicing Muslim.

Obviously, this poses a potential problem, as home prices are typically far too expensive to allow a prospective home buyer to purchase outright with cash.

The Solution

  • There are three ways this issue can be resolved
  • One being to sell the property at a higher price under an installment plan
  • Another being a “lease to purchase” contract
  • Or to create an LLC and own shares in the property
  • However, this can be solved by having the bank purchase the property and sell it back to the mortgagor (borrower) in one of three ways.

The bank will either sell the property at a higher price to the borrower under an installment plan, or rent it to the tenant/homeowner, and have them pay a contribution toward the principal balance of the home each month until it is paid off in full.

The rent price is typically established by looking at comparable homes in the area where the subject property is located.

Islamic Mortgage 2021

The second method is also known as “lease to purchase” because the homeowner “rents” the property while paying down principal and gaining home equity. Once a significant chunk has been paid down, they might be able to buy the property outright with cash.

How do I compare Islamic mortgages and find the best deal?

Islamic banks are regulated by the Financial Conduct Authority and the Prudential Regulatory Authority, so UK borrowers will be protected in the same way as if you took out a mainstream mortgage.

You can sell a property purchased on an Islamic mortgage, in the same way, you can sell a property purchased with a traditional mortgage.

you’ll need to put down a deposit – this is known as the ‘first payment’. For an Ijara plan, it’s normally a minimum of 10% of the property’s value.

Dear friends, For a Musharaka plan, the deposit can be as little as 5%. For a Murabaha arrangement, the deposit is normally at least 20% of the property’s purchase price.

The lower the FTV, the higher the deposit or first payment will be. For example, if an Islamic mortgage has an FTV of 60%, you’ll need 40% of the property price for the first payment.

In general, the lower the FTV, the cheaper the Islamic mortgage as it’s less risky for the bank. The following Islamic banks offer UK Islamic mortgages:

  1. ABC International Bank
  2. Ahli United Bank
  3. Al Rayan Bank
  4. Gatehouse Bank
  5. UBL UK

You should use an Islamic mortgage calculator to compare the total costs of Islamic mortgages offered by these banks. A mortgage broker with experience with Islamic mortgages will be able to help you find the best deal.

Mortgage Loan Originator Salary

Muslim Mortgages – An Opportunity For Investors and Islam

The question facing money-lenders who recognize the huge purchasing power of one of the most rapidly growing religions in Canada – Muslims – is, how do you lend money to someone whose religious beliefs ban the creation of money by money?

Not unlike the Christian faith, Islamic law takes a dim view of usury. In the Islamic world, the charging or paying of interest is equated to usury. So, a conventional loan or mortgage would violate the teachings of the Koran.

On the other hand, the Koran does allow money to be used in trading or investing, to generate a profit. Specifically, Islamic beliefs allow for investment based on “partnerships,” in which risk and profit are shared by the parties.

Dear friends, For the past six years, United Kingdom banks have been offering a form of Islamic mortgage, based on two Islamic principles of Ijara and Mudaraba.

Canada and the USA have entered the Islamic mortgage market slowly; a surprise was given that the number of Muslims in Canada in 2006 was estimated at 783,700 and expected to grow by over 160% by 2017.

Indeed, Islamic mortgage has been offered by one small Ontario company since 2007. That company claims to have a 5,000-person waiting list. It is difficult to dispute or challenge that claim, given that 23% of Canadian Muslims call Ontario “home.”

Also in 2007, the Bank of Nova Scotia and the Toronto Dominion Bank began an active exploration of the viability of providing mortgages that meet the requirements of those of the Islamic faith.

In 2010, the Assiniboine Credit Union in Winnipeg began offering its version of the Islamic mortgage. It is too soon to gauge how well these products will be received.

Conclusion:

Islamic mortgages are a co-ownership between you and the bank. They do not involve the same lending or borrowing that traditional mortgages do. Instead, the bank buys the property on your behalf and becomes the legal owner. You then make monthly payments.

A major impediment to the success of the mortgage concept is the CMHC insurance that is required on most home loans with less than 25% equity.

A study commissioned by the Canada Mortgage & Housing Corporation in 2007, and released this January, states emphatically, “CMHC Insurance business has no plans to insure Shari’a mortgages.”

It goes on to say that “(there is) little empirical evidence based on sound methodology assumptions exists to accurately project what portion of the Canadian population would be interested in [using] Shari’a-compliant financing.”

What Is an Islamic Mortgage
Islamic Mortgage

A final option is to create an LLC whereby the finance company and the home buyer own shares in the property.

With regard to the western world, Islamic Mortgage is probably most common in the United Kingdom, although they seem to be gaining steam in the United States as well.

Fannie and Freddie Are Investors in Islamic Mortgage

  1. Fannie Mae and Freddie Mac invest in these loans
  2. Allowing smaller banks and lenders to offer them to customers
  3. Default rates are probably lower than other mortgages
  4. Due to the straightforward terms
  5. In the early 2000s, mortgage financier Freddie Mac agreed to buy these types of “mortgages,” and at this point, others probably wish they had too.

Because Islamic mortgage tends to be more straightforward than some of the exotic offerings seen in traditional Alt-A and subprime lending, the homeowner default rate is probably a lot lower.

Fannie Mae is also an investor in these types of loans, which they refer to as “no-interest financing,” and in lieu of a mortgage, they become an investor in the property itself.

This allows smaller banks and mortgage lenders to offer the option and then sell it to Fannie or Freddie so they have funds to make new loans to future customers.

The lack of trickery and bait-and-switch has encouraged more Muslims to consider an Islamic mortgage, as it further justifies the choice.

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