Imagine a mortgage lender who allows you to take all the increase in the price of your home when you sell, but is prepared to share any loss if the property has fallen in value. Such a deal may seem too good to be true in the current property market, but it is exactly what a handful of banks specialising in Islamic home loans are offering.
Islamic mortgages have been in the mainstream market in the UK for some years but it can often be difficult to get to grips with sharia-compliant financial products, which can seem confusing. In Islam. making money from money by charging interest is deemed unfair and is not permitted. So where do you start when choosing an Islamic mortgage?
There are three models of Home Purchase Plans (HPPs): Ijara, which means 'lease' in Arabic; Musharaka, which means 'partnership'; and Murabaha, meaning 'profit'. Depending on the model, the lender will levy rent or add profit to the amount you pay back instead of charging interest.
An Ijara is a lease-to-own HPP: the bank purchases the property you want then leases it out to you. At the end of the term the bank transfers ownership of the property to you.
Under a Musharaka plan (also known as 'diminishing Musharaka'), you buy the property jointly with your provider and gradually buy the bank out of it. So if you put down 10 per cent of the purchase price, the bank will buy the remaining 90 per cent. You pay the bank monthly rent on the share you don't own as well as buying more shares in the property with each monthly payment, with a view to owning the property outright at the end of the term - hence the 'diminishing' nature of the partnership. The more shares you own, the less rent you pay to the bank, and the cost of a share in the property is based on the property's original cost price, not its market value.
In a Murabaha plan, the bank will buy the property you want then immediately sell it on to you for a profit. You then pay fixed monthly repayments on the higher price, but with no interest to pay back to the bank. So the bank might buy a property that costs £200,000 and sell it on to a customer for £250,000; the customer then pays that sum back over a fixed term.
It might be argued that charging rent or making a profit is no different to charging interest, in that ultimately the providers still make money - but as Islamic finance experts explain, it is how that money is made that is the underlying difference between Islamic mortgages and conventional ones. Farrukh Raza from Islamic Finance Advisory and Assurance Services, an independent consultancy, says: 'The issue isn't with making money, it's the conditions in which that money is made. So instead of making money through interest, Islamic banks will make money through profit or through rent when the bank owns the property as an asset. It is important to remember that Islamic mortgages simply offer an alternative financing structure which gives Muslim customers different options - it's not a 0 per cent deal to buy your house for nothing.'
HSBC has been offering sharia-compliant home finance for five years through its Islamic finance arm, HSBC Amanah, while the Arab Banking Corporation has its own Islamic HPP range, called Alburaq, which is also available through Lloyds TSB (underwritten by Bristol & West). Ahli United Bank and United National Bank also offer HPPs in the UK, and the Islamic Bank of Britain (IBB), the country's first Islamic bank, is launching
its own range of HPPs this week.
The selling of HPPs came under the Financial Services Authority's regulation last year, so customers will get the same protection as they would had they taken out a conventional mortgage.
Since there are no interest rates to compare between different Islamic mortgages, what should you look for when choosing an Islamic finance provider and home purchase plan? Nader Kamel, sales quality manager for HSBC Amanah, says: 'You should consider how much flexibility you need, and how much it will cost you to take out the financing. Are there any fees? Can you make lump sum payments? Can you rent out the property? How much rent is the bank charging you?'
HSBC Amanah started off offering Ijara plans but now offers diminishing Musharaka instead. Kamel says: 'We found customers were a little uncertain about the bank owning the property in full and only transferring it into your name at the end of term [as happens in Ijara plans], but with diminishing Musharaka, you are co-owners with the bank from the start. The knowledge that every month you are increasing your share of the property and sharing all risks with the bank, is more reassuring to customers.'
Some Islamic finance experts concede that such home deals may work out to be more expensive than conventional mortgages, but sometimes there is not much difference between them.
If you bought a property for £250,000 using a diminishing Musharaka plan from HSBC Amanah, you would pay around £1,553 a month (made up of £1,246 in rent and £307 in contribution payments to increase your share), based on the bank buying 90 per cent and you putting down a 10 per cent deposit. If you took out a conventional two-year fixed-rate loan with HSBC (at 6.29 per cent and with a £799 fee) on £250,000, you'd pay around £1,655 a month over 25 years. If you do opt for a HPP that includes rent payments, you should ask providers how much the rent and any administration fees will be.
All Islamic finance providers in the UK use the Libor index as the benchmark for rental payments, and rental rates are reviewed every six months. Both HSBC Amanah and the IBB charge rent as 6.95 per cent of the finance taken out with them (that is, 6.95 per cent of the share that you don't own, not 6.95 per cent in interest). Alburaq has three HPPs and charges a 6.76 per cent rental charge on its standard residential products, 6.56 per cent on its discounted plan (until March 2009) and 6.49 per cent on its fixed plan (also fixed until March 2009).
The rental charge percentage is the same, regardless of the size, location or value of the property. Administrative charges are lower than those on a conventional loan, however; HSBC Amanah charges a £275 application fee, while IBB and Alburaq charge £299. Providers assess whether you can afford the loan in the same way as they would for a conventional mortgage, and, if approved, you can be given the equivalent of a mortgage in principle.
Islamic finance products are not just for Muslims - around 2 per cent of the IBB's customer base are non-Muslim and don't choose the bank for religious reasons, but for ethical ones. Islamic banks will not invest in firms involved with gambling, alcohol, tobacco or pornography.
Sultan Choudhury, commercial director at the IBB, says: 'Our products are open to everyone and customers who aren't Muslim choose the bank because of its ethics. Because of the nature of our investments, we are an ethical provider, and, increasingly, that is what people want.'