If you’re looking to buy a home, it can be difficult under Sharia law where the payment of interest is forbidden.
However, there are now several lenders in the UK who offer Sharia-compliant mortgages, with one new lender claiming that they are also an ‘ethical’ choice for borrowers.
So, what is a Sharia mortgage? How does a Sharia mortgage work? Where do you get a Sharia mortgage? And how ethical are they? Keep reading for answers to these questions and more in your complete guide to Sharia mortgages.
What is a Sharia mortgage?
A Sharia mortgage is a specific type of product, often called a ‘home purchase plan’. Under the plan, you do not pay interest on the loan from the lender as this is forbidden under Sharia law.
Under a Sharia mortgage, the lender buys the equity in your house that is not covered by your deposit and becomes the legal owner. You and your lender then agree to a fixed payment period, and you effectively buy the property from the lender through a series of monthly instalments.
Your monthly repayment is a combination of:
- payment of the capital which increases your share of the property
- rent on the stake in the house that the lender owns.
The rent is set at a fixed rate, similar to the way that interest would be fixed on a traditional mortgage.
At the end of the agreed period you will own your home outright. You can also sell the property at any time.
How do Sharia mortgages work?
Here’s an example.
You decide to buy a property for £250,000 and you have a £100,000 deposit. You put down your deposit and then the lender buys the remaining £150,000.
Your lender is the registered owner of the property but will retain that ownership for both itself and as your trustee. You have the right to buy the lender’s share at any time at the same price they paid for their share.
A lender will assess affordability in much the same way as they would for a traditional mortgage. Your income and expenditure will be considered to determine whether the borrowing is affordable to you.
Most specialist lenders offer a range of products including fixed and variable rates and the cost of these products depend on the amount of deposit you put down and the deals offered by individual lenders. As with a traditional mortgage, you will generally revert to your lender’s Standard Variable Rate (SVR) when your deal ends.
Only one amount of Stamp Duty is payable, even though the property is being bought twice (once by you and once by your lender).
Charles Haresnape from Sharia mortgage provider Gatehouse says: “It is a little-known market, but there are lots of similarities to Shared Ownership mortgages.
“You pay back capital each month but instead of paying interest you pay rent on the portion you don’t yet own. It is rental payment rather than interest.”
How do Sharia mortgages compare to traditional mortgages?
In the UK, there is only a handful of lenders that offer Sharia-compliant mortgages (see ‘Where can I get a Sharia mortgage?’ below).
If you are focusing entirely on the cost of your new mortgage, then home purchase plans/Sharia mortgages can be expensive when compared to the rates on offer for traditional mortgages.
For example, according to financial data analysts Moneyfacts the average two-year fixed-rate mortgage deal is around 2.5 per cent. If you have a larger deposit the rates on offer fall to around 1.4 per cent.
New lender Gatehouse has launched Sharia-compliant mortgages, available to a maximum 50% loan-to-value. If you’re a UK resident, you can take advantage of a two-year fixed-rate deal at 3.19%, with a £499 arrangement fee. There is no early repayment charge.
This is significantly higher than the average two-year deal, and almost three times as much as the very best mortgage deals at a low loan-to-value.
So, if you simply want the best deal then it’s unlikely you’ll find it with a Sharia mortgage. However, if you need your borrowing to be Sharia-compliant, this is certainly an option.
In addition, the fact that no early repayment charges are applicable gives you some additional flexibility when it comes to moving home or paying off lump sums.
Gatehouse also offer Sharia-compliant mortgages to UK expatriates and to international buyers, so if you sit in this niche then these products may be suitable for you.
Read: Why you should take rates and fees into account when choosing a mortgage
Where can I get a Sharia mortgage?
There are a handful of UK lenders that offer home purchase plans and Sharia-compliant mortgages. They include:
- Al Rayan Bank (thought to be the largest provider of this type of product to UK clients)
- ABC International
- Ahli United Bank
- UBL
- Gatehouse Bank.
Products, maximum loan-to-values and eligibility criteria vary from lender to lender.
Is a Sharia mortgage an ethical mortgage option?
While Sharia mortgages are suitable for Muslim clients looking for a scheme that complies with Islamic law, many banks are also marketing these products to other customers as an ethical option.
For example, Gatehouse Bank’s entry into the market targets both borrowers with religious requirements and homeowners looking for ethical finance.
Charles Haresnape, of Gatehouse, says: “We believe that Sharia finance, regardless of religion, is ethical finance. People want a good deal, but they want to know it is ethical.
"We will not finance the arms trade, gambling or alcohol. No major banks can give those assurances. Young people are very conscious of these issues.”
Read: Your guide to green and ethical mortgages