What Are Islamic/Sharia Mortgages and How Do They Work?

The journey to homeownership can be daunting, especially when your faith dictates specific guidelines. Under Islamic law, traditional mortgages are viewed as haram (forbidden). Therefore, Muslims prefer a halal (permissible by law) alternative when buying homes. 

If you are looking for the best provider for Halal mortgages in Australia, Islamic mortgages offer a Sharia-compliant form of finance that permits Muslims to enjoy the luxury of home ownership while remaining true to their beliefs.

In this article, we take you through this innovative finance option and explain how it operates.

What are Islamic Mortgages?

Commonly known as Halal or Shariah mortgages, Islamic mortgages are home financing options that comply with Islamic (Shariah) law. This means that they don’t have the traditional interest payments, which are ‘haram’ as per Islamic law.

What sets Halal mortgages apart from conventional ones is their structure. While conventional mortgages involve borrowers paying interest to utilize the lender’s funds, Halal mortgages do away with interest payments. Instead, they adopt a profit-sharing model where the bank and borrower are equal partners who share risks and returns equally. 

How Do Islamic Mortgages Work?

Islamic mortgages follow a profit-sharing or lease-to-own model. First, the client identifies a property they wish to acquire. The bank then buys this property and sells it to the client at an often higher price. 

This amount must be paid in instalments over a pre-calculated period, bypassing the charging of common interest. The institution’s profit is only compensation for the risk it undertook.

Types of Islamic Mortgages

There are three main Sharia-compliant mortgages in Australia. Musharakah (partnership) is the most popular one for residential purchases. Murabaha (profit) and Ijarah (lease) are also used, although they are more common in commercial transactions. 

Musharakah

This is a form of co-ownership between the financier and the home buyer. The two parties agree to jointly invest in a property and purchase the home. In a version known as Diminishing Musharakah, the home buyer buys out the financier’s stake in the property over time while paying a fee to use the portion of the property still in the financier’s ownership. Your monthly repayments are divided into part rent and part capital, allowing you to purchase more of the financier’s share with each repayment.

A typical term is approximately 25 years, which matches the length of a mortgage term.

. Over this period, your property share grows as your rent reduces; hence the term diminishes. The bank’s share also decreases over time. Eventually, you’ll own the entire property. This operates the same way as a traditional mortgage, only that the interest is replaced with rent to ensure adherence to Sharia law.

Murabaha

This form of Islamic mortgage operates in a slightly different way. Instead of asking you to pay rent, the lender purchases the property before selling it to you at a higher price. You purchase your house from them in equal instalments over a predetermined period, typically 25 years.

In this case, provided you make your monthly payments on time, you are considered the homeowner from the beginning rather than being in a partnership with the lender. In Australia, Murabaha is commonly used to purchase commercial property such as business premises and buy-to-let rentals.

Ijarah

In this lease-to-own arrangement, the bank buys the property you want and then leases it back to you. A part of each payment goes towards the tenant’s future property ownership, and the home can only be registered in the buyer’s name when the repayment is complete.

Ijarah isn’t often used for residential purchases, as most buyers would need to resell the property upon the expiry of the lease to help repay the loan. However, it is commonly used to acquire buy-to-let properties as the monthly repayments will be less than for a Diminishing Musharakah. This is because you won’t be repaying any of the amount borrowed. 

When evaluating the options available, you can consider the type of property, your financial situation, and your long-term goals.