Sharia compliant home buying guide

Islamic law, also known as Sharia law, dictates that followers of Islam should not take out a mortgage that includes interest rate repayment because charging interest goes against Sharia law. The practice of charging interest is described by the Arabic word Riba – which roughly translates in this context to usury. In modern terms, usury means the act of lending money with an exploitative or unlawful interest rate. However, in old-English terms, which Riba better relates to, usury is the practice of making money from interest – no matter how small the amount. As described in the Surah al-Baqarah, verses (275-81) of the Quran:

“The standing of those who eat Riba is like standing of the one who is confounded by Devil’s stroke – that’s because they say trade is just like Riba, whereas Allah has permitted trade and forbidden Riba. Hence those who have received the admonition from their Lord and desist, may keep their previous gains, their case being entrusted to Allah; but those who revert shall be the inhabitants of the fire and abide therein forever”

This means that because Muslims cannot take out a conventional mortgage, many families struggle to make it onto the property ladder. In keeping with Islamic law, many Muslims who cannot afford to buy a property outright choose to rent.

To combat this, Sharia-compliant mortgages or Islamic mortgages have been established. Islamic mortgage lenders do not charge interest giving Muslims the chance to own a home. Some people may think that they do not qualify for these mortgages because they are of a different faith. However, the reality is that you do not need to be a Muslim to open an Islamic bank account, and you do not need to be a believer to take out an Islamic mortgage.

What is an Ijara mortgage?

There are three different types of Islamic mortgages. These are:

  • Ijara
  • Murabaha
  • Diminishing Musharaka

Under Sharia law, Muslims are not permitted to take out a traditional mortgage – that charge a monthly interest fee along with repayments. One Sharia mortgage method is Ijara. Ijara Islamic mortgages do not involve paying interest. Any money lent out is asset-based and not credit based. The person taking out a Sharia-compliant mortgage this way is a lessee rather than a debtor.

Instead of conventional mortgages, an Ijara mortgage sets up a trust which owns the property. You then pay rent to the trust, and part of these monthly payments are used to buy the property. As Sharia law forbids unequally shared risk (Gahrar or Gharar), the trust is the legal owner of the property until you have paid the entire purchase price. The trust, as the legal owner, is responsible for 100% of losses or gains, which in turn are passed to the beneficiary. All monthly repayments are used as rent, but they also go towards saving to buy the property in full. In essence, these monthly payments increase your percentage ownership, but the trust is still the legal owner.

Even though you are classed as a renter, you have added benefits using an Ijara Islamic mortgage. For example, you can redecorate however you like. Furthermore, you can sell the property anytime, even if you have not paid off the entire purchase price. This type of Islamic mortgage works in a similar way to a lease-to-own car loan. In Ijara no interest is paid, but an added fixed amount is added to the bill to make it financially profitable to the lender.

What is a Murabaha Islamic mortgage?

Murabaha is another option on the Islamic mortgage market. When you take out one of these Islamic mortgages, a lender such as a bank will buy the property from a seller. The financial institution will then sell the property back to you at a slightly higher price. For example, if the property costs £100,000 you may have to buy the property from them for £110,000. The agreed-upon profit margin is not interest but the sale of a commodity for money.

In keeping with Sharia law, monthly repayments are fixed without fluctuating interest rates like non-Islamic mortgage alternatives. To make a property purchase this way you will need to put down a larger deposit that most other mortgage options. A typical deposit is at least 20% of the total property price. Murabaha Islamic mortgages mean that the property belongs to you as soon as you pay the deposit.

Along with the monthly price of repayments, the length of the mortgage is fixed. Furthermore, when buying using this type of Islamic mortgage, there is no extra charge for paying the full amount early.

What is a Diminishing Musharaka Islamic mortgage?

Diminishing Musharaka Islamic mortgages are a co-ownership agreement. Islamic banks will buy houses in partnership with their customers. So, you and the bank will buy a property together with separate stakes in the building. Over time you will buy out the lender’s stake in the property.

With every monthly payment, your share in the property grows while the lender’s will shrink. Monthly payments are part rent, part capital and part charge. When you have completely bought ought the bank’s share of the property, it is yours in its entirety.

This means you are no longer paying rent, and the title will be transferred to you by HM Land Registry.

What are the drawbacks vs benefits of halal mortgages?

The main drawback of Islamic mortgages is the initial downpayment costs. Unlike other traditional mortgage types that require as little as 5%, an Islamic mortgage has higher deposit requirements. Islamic banks usually charge at least 15% for a deposit, meaning it is harder to initially get on the property ladder.

However, when you have put down your deposit for a sharia mortgage, things start to look more positive. As you have put down a large deposit, a good share of the property is already paid for. For example, a 20% deposit is almost one-quarter of the entire price. Also, as you do not pay interest, the monthly cost for the property remains constant. In the long run, you will pay less each month which helps keep finances more manageable as other living expenses rise.

Also, if you are Muslim, using an Islamic mortgage allows you to adhere to the Islamic faith. However, even amongst non-Muslims, there is a growing opinion that Sharia-compliant mortgages are more ethical than interest-bearing loans.

How much does it cost to buy a home in the UK as a Muslim?

It all depends on the size of your deposit, where you want to buy and the cost of the property. However, it is helpful to look at some average figures to get an idea of how big your mortgage repayments can be.

As of June 2022, the average house price in the UK is £286,000. This means that the smallest deposit (15%) for an Islamic mortgage for the average UK home is £42,900. Given that the average salary in the UK is only £25,296 this is a hefty deposit target to meet. This is even more expensive in England, where the average house price is £295,888.

Let’s take a look at average property prices in Birmingham, which has the largest population of Muslim people per 1,000. We can bring down the deposit in line with the average property price in the West Midlands. The average property price in the West Midlands is £234,141. So a 15% deposit for a house in this area is £35,121, which is marginally better but still outweighs the buying power of the average wage.

What additional costs are there to buying a house?

As with a standard mortgage, an Islamic mortgage comes with additional costs. For example, you may have to pay Stamp Duty tax depending on how much your property costs and if it is a first-time buy or not. Stamp Duty is known as Land and Buildings Transaction Tax in Scotland or Land Transaction Tax in Wales. First-time buyers will get a discount for properties that cost less than £500,000.

The tax-free limit is £150,000 meaning the average person will have to pay either 2% or 5% as the average house costs more than this. The percentage is the percentage charge above the limit. So, if the property costs £160,000, £10,000 of that comes with an additional 2% (lowest rate) Stamp Duty charge.

You will also have to pay legal costs to make the purchase legally binding. This typically costs £850-£1,500, plus additional legal fees (£250-£300) for local searches. You’ll also need to pay for a survey. This costs anywhere from £250 to £600, and it is done to uncover any potential structural defects in the building. A Sharia mortgage lender may also charge a valuation fee to ensure the house they are buying on your behalf is worth the price. This costs around £150-£1,500 – with pricier houses fetching higher fees.

In general, there is also an electronic transfer fee. This covers the cost of transferring the money for the mortgage from the lender to the solicitor. This is around £40 to £50. Also, you will likely have to pay the cost of removal specialists to transfer your furniture to your new home. The general price range for this is anywhere between £300 to £600.

Sharia-compliant mortgages: Summary

As dictated by Shariah law, Muslims are not permitted to do business using interest. This includes purchasing housing using mortgages with interest repayments. This has disadvantaged Muslims in the UK in terms of home ownership as it is harder to climb onto the property ladder. As there are fewer options to borrow money to pay for housing, many Muslims may choose to rent instead of buy. As rent is typically more expensive whilst offering no investment, Muslim people are further disadvantaged.

However, Islamic mortgage alternatives have become more commonplace in recent years. The three different mortgage alternatives are:

  • Ijara
  • Murabaha
  • Diminishing Musharaka

These types of mortgages allow Muslims to borrow for the lucrative investment that is house ownership without breaking Sharia law. Instead of paying back a lender using the conventional process of charging interest, different methods are used. Typically the bank buys the house and sells it back to you at a higher price over time. However, monthly amounts are fixed and do not fluctuate with increasing and decreasing interest rates.