Types of Islamic Mortgage available in the UK: All you need to know!

May 27, 2020 | Shakeel Mir

islamic mortgage typesOne of the fastest expanding financial services sectors globally is Islamic finance, which has consistently shown growth rates of circa 10% to 12% annually over the past two decades. The theological basis for Islamic finance stems partly from the traditional prohibition of usury or interest, which means that interest-bearing loans may not appeal to followers of Islam.

Islamic Banks offer a product called the “Home Purchase Plan”, commonly referred to as an Islamic Mortgage, which allows Muslims to purchase a house whilst avoiding the payment of interest. These financial products have been developed so that they fall within the regulatory and legal framework of England and Wales and so introduce no new concept in HM Land Registry terms. They are available in the UK to Muslims and non-Muslims alike.

What are the different forms of Islamic Mortgage?

There are three different forms of Islamic Mortgage available in the UK. These are:

Diminishing Musharaka

The Diminishing Musharaka structure is the most common structure available in the UK and you will almost certainly be using this structure if you are getting a Home Purchase Plan. Musharaka means ‘partnership’ or ‘joint venture’. There are various ways in which this partnership can operate in the context of a Home Purchase Plan. Typically, a customer would like to purchase a house for which they do not have sufficient funds. In these circumstances the bank might, for example, agree to pay 80% of the purchase price, the remaining 20% being paid by the customer. The legal title is transferred to the bank, the bank and the customer, or a third-party trustee and then the property is leased to the customer.

The property is normally held on trust for the bank and the customer. A separate diminishing partnership contract is entered into between the bank and the customer to split the beneficial interest in the property depending on each party’s contribution to the purchase price. In our example, the bank would be entitled to 80% of the beneficial interest while the customer’s beneficial interest would be 20%.

The bank will reduce its equity in the property against the periodical payments which are made by the customer, ultimately transferring ownership of the asset. With each payment made by the customer, the bank’s equity is reduced and the rental payments are also reduced over the agreed period of time.

After the property is purchased, the customer uses the property for their own residential purposes and pays rent to the bank for using its 80% share in the property. The lease to the customer will normally be a registrable disposition and may also be charged to the bank.

In addition to the rental payment, over time the customer buys the bank’s beneficial interest in the property and eventually becomes owner of the bank’s 80% share. At this stage, the customer’s total rental payment is zero and the title will be transferred to the customer at HM Land Registry.

The Diminishing Musharaka mode of finance allows the bank to claim rent according to its proportion of ownership in the property and at the same time allows the bank periodic returns of the principal finance sum, as it is repaid in stages.

The bank will give an undertaking to the customer at the outset to transfer back the property at the end of the term or when the arrangement is ended.

This type of mortgage is used for financing a house purchase, and for existing homeowners switching from an interest-bearing mortgage.

Ijara wa Iqtina

Ijara is a lease of an item by its owner to a customer and Ijara wa Iqtina is a lease of an item usually followed by the eventual sale of the item to the customer at the end of the lease term. In the case of a property purchase using Ijara wa Iqtina, the bank will purchase the property chosen by its customer for an agreed price and then will grant a lease to the customer. The lease will usually be long enough to require registration under the Land Registration Act 2002. This type of mortgage is used both for financing a house purchase, and for existing homeowners switching from an interest-bearing mortgage.

The ownership of the property remains with the lessor (the lender) and the client has the right to live in and use the property.

The customer’s monthly ‘mortgage’ payments will normally comprise both the rental payment as well as an amount held by the bank to act as a guarantee that the customer will be able to pay for the purchase of the property at the end of the lease term. The monthly ‘mortgage’ payments are fixed in such a manner that the bank gets back its principal sum along with some profit.

The bank also gives an undertaking to the customer to transfer the reversion of the property to the customer at the end of the term or when the arrangement is ended. When the customer wants to sell or end the arrangement, they can give notice at any time to the bank and the property is then either transferred to the customer for the price originally agreed less the on-account payments, or the customer can direct the lender to sell on to a third-party, arrangements being made for the termination of the lease.

Murabaha

Murabaha is a sale of an item to a buyer where the seller expressly mentions the cost they have incurred on the property to be sold and sells it to you as a buyer by adding some profit or mark-up which is known to the buyer. To implement a Murabaha mortgage, a bank will buy from the seller the property that is required by its customer for an agreed price, and immediately sells it to the customer at an agreed profit margin over cost. Thus, Murabaha is not a loan given on interest; it is a sale of a commodity for money.

The customer will pay the price of the property in installments over several years, and mortgage the property to the bank in order to secure the installments that are due.

Until the property is sold to the buyer the lender will bear the risk associated with ownership of the property.

In the UK, the Murabaha structure is often seen in a buy-to-let scenario, in commercial property development financings, and in bridging financing situations. It is not typically seen for a residential Islamic mortgage.

islamic mortgagesHow Elite Law Solicitors can help

Shakeel Mir is a Partner and the Head of our Residential Conveyancing team. He has extensive experience in dealing with Islamic Mortgage conveyancing and has assisted many Muslim and non-Muslim clients with purchasing or re-mortgaging a property.

If you have any queries relating to any of the issues discussed in this article, please get in touch with Shakeel by calling 0800 086 2929, emailing info@elitelawsolicitors.co.uk or completing our Free Online Enquiry Form.

The content of this article is for general information only. The information in this article is not legal or professional advice.

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