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How is a Halal mortgage different from a traditional mortgage?

June 2, 2022

Have you ever wondered how halal mortgages are different from conventional mortgages? There are some practical differences between the two. These are three main differences:

  • Islamic mortgages are known as halal
  • There is no interest involved with a halal mortgage
  • Islamic mortgages will involve ownership for the bank

According to some scholars, the main difference is that an Islamic mortgage complies with
sharia law. On the other hand, traditional mortgages do not. An Islamic mortgage is halal, and
any traditional mortgages are considered haram. Why is this so? The reason is due to interest.
Islamic mortgages offer the borrower zero interest rates. This means that a borrower’s repays to
the bank are different under different types of loans.

One other difference is how the borrower will own the property and the risk profile once the loan
is taken out. Here are the practical differences, specifically the repayment and ownership.
Many people will take out something known as a repayment mortgage in a conventional
mortgage. This means that you will pay the bank both the interest and part of the capital or
money you borrowed each month. This is the type of payment that is considered haram for
Islamic borrowers.

With a traditional loan, you will be the property’s freehold, meaning that you will own the house.
So if you take this loan, you will be responsible for anything that happens. But when the bank
loans money to buy the home, they will take a legal charge on the property. If the borrower
defaults on the mortgage, the lender will need to exercise power to sell the property to help
recover the loan.

The legal charge will be taken off of the property’s title when you have finished repaying the
loan. Then, this makes the home belong to the borrower. However, the power the bank has over
the borrower is of little value if there are defects or problems on the title, which act to reduce the
value of the property, so the lender cannot recover the money owed.

They are considered under home purchase plans or HPP with an Islamic mortgage. There are
currently three different types of HPP:

  • Ijara or rent only (lease)
  • Diminishing musharaka (partnership)
  • Murabaha

The common method used for residential mortgages is the diminishing musharaka plan. The
bank will own 80% of the home, and you will pay rent which buys further equity until you are the
owner 100%. Or, for example, the bank will be holding 80% of the property on its accounts,
compared to $80k in debt. The difference here is that no interest will be paid on the borrowed
money. It should be considered as rent.

When it comes to ownership differences, Islamic mortgages are designed to avoid paying
interest and are considered a partnership model where the bank will take freehold, compared to
a conventional mortgage where you take freehold.

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