An Islamic mortgage is different from a conventional mortgage as there is no interest charge on Islamic loans. Shariah law forbids charging interest on money lending because a loan must be a helping hand from one person to another as a kind gesture of charity and the lender can only expect to receive back the amount of money they lent out.
A conventional mortgage secures the loan against the value of the property. The borrower owns the land and retains the rights and privileges of ownership. If the borrower fails to keep up repayments, the lender could force them to sell their home or land to get their money back.
Under Shariah law the mortgage is not a debt. Buying a home is a partnership between the borrower and the lender, sharing the profits or losses of the property. The bank or the lender buys the property on the buyer’s behalf and then resells it to the buyer at a profit. The buyer pays back the cost of the home to the bank in monthly instalments, which is similar to a conventional mortgage.
Islamic home financing has always been available in Middle Eastern countries and is increasingly available in the Western World. So let’s define and compare conventional mortgages and Islamic mortgages in more detail.
Conventional Mortgages
Conventional mortgages are the most common type of mortgage around the world.
Financial institutions and mortgage lenders lend money to buy homes and charge a specific rate of interest on the loan. The amount of interest is commensurate with the level of risk. A home loan is a low risk for a bank so the interest rate is low. In fact, home loan interest rates are the lowest rates you can get. Compare that to a motor vehicle or business loan where the risk is higher and the interest rate is a lot more than a home loan rate.
Home purchasers borrow money secured against the property. The loan repayment is calculated to pay back the principal value of the loan and an element of interest on the borrowed money. Usually, the loan period is up to 25 years but can be repaid at an increased rate to reduce the term of the loan.
The lender registers a mortgage document on the land title to record a claim against the property. When the loan is repaid in full the mortgage security is released. If the mortgagee fails to make repayments the bank can take possession of the property and sell the property to recover the outstanding value of the loan.
Islamic Mortgages
An Islamic mortgage is complies with the requirements of Shariah law. Shariah law prohibits charging interest on lending money.
Mostly, only persons of the Islamic faith utilize Islamic finance to comply with the requirements of Shariah law. However, any one can take out an Islamic mortgage.
Many people believe that Islamic Mortgages are better than conventional interest-based mortgages as there are no interest on the loan.
Islamic Mortgage: Not a Debt
Under Islamic finance, the Islamic mortgage is not a debt. It is a purchase and leaseback arrangement with the bank. The bank and property purchaser enter into a partnership of ownership where the purchaser makes payments to the bank for possession of the property.
Islamic Mortgage for Off-Plan Construction
Islamic finance is perfect if you are purchasing a property off the plan and it won’t be ready for many months or years. You won’t have to pay anything until the property is finished and ready for occupation.
Islamic Mortgage: No Interest Charge
Islamic mortgages have no interest applied to the loan. The financial institution buys the property on your behalf and leases the property back to you at a profit to the bank. There is no interest charge on the loan as the contract has a profit margin.
Islamic Mortgage: No Late Payments or Defaults
As there is no interest on the loan, late payments are irrelevant. The profit margin is calculated at the commencement of the Islamic finance and is not affected by frequency of payments. If you miss a payment it will take you longer to buy the property.
Islamic Mortgage: Shorter Mortgage Terms
Conventional mortgage terms are typically 15 to 25 years depending on how much money is borrowed. Islamic mortgages are much shorter in duration with most mortgages repaid within 8 years. Shariah law prohibits lending money for long periods of time. Most people with an Islamic mortgage repay the loan in 5 years.
Conclusion
Islamic mortgages follow the rules of Shariah law which prevents buying or selling anything that has no intrinsic value. Money, itself, has no intrinsic value in Islam. Shariah law prohibits paying money to borrow more money.
If you are purchasing a property in the Middle East region you will most likely get an Islamic mortgage to finance the property. However, Islamic finance is now available in many countries around the world. If you like the idea of not paying interest on money and leasing a property back from the bank check out Islamic finance. It may be better for your financial future even if you are not a Muslim.