Sharia-compliant savings accounts and mortgages operate by Islamic principles. However, you don’t need to be Muslim to apply for one.
Here, we explain exactly how Sharia savings accounts and mortgages work to help you understand whether they could be right for you.
What is Sharia banking?
Sharia banking complies to Islamic law and beliefs. Central to Islamic finance is the fact that money itself has no intrinsic value.
Under Sharia law, no interest (‘riba’) can be paid on Islamic savings accounts and no interest can be charged on borrowing, including mortgages.
Additionally, money held in a Sharia bank cannot be used for non-Sharia approved activities. This means it must not be loaned to businesses to provide goods or services such as gambling, tobacco and alcohol, and Islamic banks must not deal in investments that involve extreme uncertainty or speculation.
Islamic banks usually use a Supervisory Board to ensure their financial products are Sharia-compliant.
Do Sharia-compliant banks offer mortgages?
As well as Sharia-compliant savings accounts, you can also apply for a Sharia-compliant mortgage. Because charging interest is against Sharia law, Islamic banks offer products known as home finance or home purchase plans.
There are different types of home purchase plan, but they work in a similar way. The bank buys the property on your behalf and becomes the legal owner. You then make monthly payments to the bank as if you were paying rent and a portion of these payments goes towards buying the property.
At the end of the term you will either have repaid the bank in full and will now own your home outright, or you will still need to pay an outstanding sum to become the legal owner.
As with Sharia savings accounts, anyone can apply for a Sharia-compliant mortgage. However, deposit requirements tend to be higher than for other types of mortgage. You will usually need to have saved up at least 20% of the property’s value.
On top of this, you will need to budget for stamp duty, surveys, legal fees and buildings insurance.
What are the different types of Islamic mortgage?
There are three main types of Islamic mortgage:
Ijara With this type of home purchase plan, the bank purchases the property for you and you pay an agreed rent to lease it back from the bank. Your payments should be fixed for the duration of the term and will cover some of your rent and some of the capital. At the end of the term, the capital should have accumulated to pay off the bank’s share of the property and you’ll become the legal owner.
Murabaha This type of Islamic mortgage is most commonly used to buy a commercial property. The property will be bought by the bank on your behalf and the bank will immediately sell it on to you for a higher price. The profits made by the lender are seen as acceptable under Sharia law as it is viewed as a fair trade transaction. Your monthly payments should remain the same for the length of the term and you can pay off the amount you owe at any time, penalty-free.
Diminishing Musharaka This is a co-ownership agreement where you and the bank own a separate portion of the property. Your deposit is your initial share of the property and the remaining share belongs to the bank. You then make monthly repayments consisting of rent and capital to purchase the shares owned by the lender over a set term. This means your ownership grows as the lender’s reduces. It’s often considered similar to a repayment mortgage.
What are the risks of an Islamic mortgage?
Similar to other mortgages, if you are late or miss any repayments on your Islamic mortgage, it’s likely you’ll pay a penalty fee. If you repeatedly fail to make your payments on time, your home could ultimately be repossessed.
In addition, some Islamic mortgage providers use LIBOR-pegged values to work out your rent, rather than the average rent levels in your area, which could result in you paying more than you would otherwise.
Finally, note that the number of lenders you can choose from is lower compared to other mortgage types, which means deals can be more expensive because of reduced competition for your business.
How does a Sharia savings account work?
A Sharia savings account will pay an ‘expected profit rate’ rather than interest. Your money will be used by the bank to buy and sell Sharia-compliant assets with the intention of generating a profit. A share of this profit is then passed on to you.
It’s called an ‘expected’ profit rate because the rate of return isn’t guaranteed. However, in the vast majority of cases, the bank will deliver its expected rate to customers.
Should a bank believe it won’t reach its expected profit rate, customers should be informed in advance. They will usually have the option to close their account and withdraw their money, including any profits already earned.
The expected profit rate will be advertised as a percentage to enable you to easily compare it against the interest rates on offer from standard, non-Sharia savings accounts.
What types of Sharia savings accounts are available?
Similar to other savings accounts, you can choose from a number of different Sharia savings accounts. These include:
- instant access savings accounts – giving you access to your money whenever you need it
- notice accounts – requiring you to give up to 120 days’ notice to access your funds, but offering a higher expected profit rate than instant access accounts
- fixed term deposit accounts – paying the highest expected rate of profit, but you will need to lock your money away for between six months and five years
- cash ISAs – some banks also offer tax-efficient cash ISAs. In the current 2022/23 tax year, you can pay up to £20,000 into an ISA.
Who can open a Sharia savings account?
Although they are commonly used by Muslims wishing to adhere to Sharia law, anyone can open a Sharia savings account, so long as they meet the standard eligibility criteria. This includes providing proof of identity and of address.
Some of the benefits of opening a Sharia-compliant savings account include that they regularly top the best-buy tables, and they can help you to bank in line with ethical principles.
Are Sharia savings accounts covered by the FSCS?
As long as the Sharia-compliant bank has been authorised by the Financial Conduct Authority (FCA) or the Prudential Regulation Authority (PRA), your money will be protected by the Financial Services Compensation Scheme (FSCS).
This means that savings of up to £85,000 per person, per banking institution will be covered in the event your bank ceases trading. This level of protection rises to £170,000 for a joint account.
