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A guide to how sharia-compliant mortgages work

Paul Stockwell, chief commercial officer at Gatehouse Bank | 08:59 Wednesday 9th October 2019

In December 2018, we launched an alternative to traditional home loans, a home purchasing plan (HPP) for buyers in the UK, abroad and expats.

HPPs are currently only available from a few sharia-compliant providers, but the products are growing in popularity among both Muslim and non-Muslim consumers looking for a competitive, yet ethical, way to buy a house.

An HPP is a sharia-compliant product which is often referred to as an Islamic mortgage, but this term is misleading. While the outcome is the same — in that an HPP and a traditional mortgage result in the customer owning the property — there are a number of important differences. Since launching, we’ve seen huge demand for these plans. 

How does a home purchase plan differ to a traditional mortgage?  

Unlike a traditional mortgage, whereby a buyer borrows a fixed amount from a bank to buy a house and then pays this back plus interest over a set term, with an HPP the bank and the buyer purchase the house in partnership. 

The bank does not charge interest, as this is not allowed in Islamic finance, but instead charges rent on the part of the property that the customer doesn’t yet own. The buyer also pays an additional amount each month to gradually purchase the bank’s share of the property over a set period.

There are two types of home purchase plan:

  • Rent and acquisition — the proportion of the property the bank owns reduces over time as each monthly payment includes a payment to the bank to acquire a small portion of the bank’s share. Over time, the customer acquires all of the bank’s share and takes full ownership of the property at the end of the finance term. This is similar to a repayment mortgage.
  • Rent only — the equivalent of an interest-only mortgage. Customer payments only cover the rental payment on the proportion of the property they do not own. At the end of the finance term, the customer will need to pay a lump sum to acquire the bank’s share.

How is an HPP different to a shared ownership mortgage?

Buying a house through a home purchase plan has many similarities to a shared ownership scheme, as buyers pay both rent and a proportion of the house value until they own the property. 

However, one major advantage of buying through an HPP is that when buyers increase their stake in the property, the amount they pay is based on the value of the house when they purchased it.

With shared ownership schemes, the value is based on the current market rate — which could be significantly higher than when they first entered into the agreement. This is a huge bonus for the buyer given how fast house prices have risen over the past decade. 

There are also no early payment fees (excluding legal charges) if the buyer wants to end the agreement early and pay off the whole amount, even if they’re in the middle of a fixed term agreement.

Landlords can also benefit

Landlords can also benefit from sharia-compliant home finance products, with some providers offering buy-to-let purchase plan (BTLPP). The BTLPP is similar to a home purchase plan offering an ethical alternative to a conventional buy-to-let mortgage. 

In addition, there are no early payment charges on a BTLPP either (excluding legal charges). Since Gatehouse Bank first started offering BTLPPs in 2017, we’ve seen a huge increase in demand from both UK and international landlords.

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