Midweek Money: Borrow in good faith

Millions of mortgage borrowers tend to take for granted the likely availability of a home loan package that meets their needs. Yet UK lenders have signally failed to deliver suitable products to one section of society.

For many years, more than 1.5 million Muslims living in the UK have had to compromise their beliefs to buy a house. The payment or receipt of interest is not legal in Islam. It is forbidden in the Koran, and that removes the possibility of taking out a mortgage with high street lenders and complying with Islamic Law.

Although attempts have been made by the Islamic Investment Banking Unit (IIBU), a division of The United Bank of Kuwait, to respond to this need by launching a Muslim mortgage in the UK, until recently aspects of it had fallen foul of Islamic Law.

The Murabaha Plan, launched in 1997, works on the basis of trading, or buying and selling goods, at a profit. The bank buys the house for the client and then sells it on to him for a higher price. This plan can be used by Muslims to buy a house, but not to re-mortgage. This is because under Islamic Law, or Sharia'a, it is unacceptable for a bank to buy the house from its owner and sell it back at a higher price.

So at the start of the year, IIBU launched a re-mortgage product, the Ijara Plan, which enables Muslims to get out of an interest-paying mortgage contract with a high street lender. With this re-mortgage plan, the bank buys the house from the owner, pays off the mortgage with the original lender, and then "rents" the property back to the client.

Keith Leach, financial services manager at the Islamic Investment Banking Unit, says: "Part of that rent gives us our profit and covers our costs, and at the same time they get to buy the house from us for a deferred period, say 25 years."

The Ijara plan will have the pricing of its "rent" altered every year, so economically it will be equivalent to a variable interest rate mortgage, according to Mr Leach. He adds: "The numbers might equal the same as interest, but technically, legally, and structurally, they are not paying us interest."

For both plans, the client has to pay 20 per cent of the value of the property as a down-payment. This is a large amount in comparison to the high street lenders, but as an Islamic company, the IIBU does not want to "encourage people to take on excessive financial commitments", and so spurns insurance products. Consequently, it takes a more cautious approach to the amount of finance that is available to individuals.

Another drawback for both home-buying plans is that the customer is not eligible for mortgage interest tax relief (Miras), as he is not paying the bank interest. However, this now amounts to barely pounds 20 a month and the signs are that the Government plans to reduce Miras further.

One problem with the original Murabaha Plan is that the repayment term is only 15 years, making it too expensive for many people. The Ijara plan can offer payment terms over 25 years.

The IIBU already has 80 clients for the Murabaha Plan, with approximately another 20 applications currently being processed, and has already received its first applications for the Ijara plan. The IIBU believes that these are the only mortgage products on the market to comply with Islamic law, but they are not the first to be offered in the UK.

The Bank of Credit Commerce International (BCCI), which was particularly popular with the Asian community, did offer a Muslim mortgage before it was famously closed down by the Bank of England in 1991.

Albaraka International Bank, the British division of a Saudi Arabian finance institution, also offered Muslim mortgages, but voluntarily surrendered its banking licence and re-paid all its depositors in 1993.

After the BCCI shutdown, Muslims had good reason to mistrust the banks, and that mistrust is thought to have contributed to the slow initial take- up rate of the Murabaha plan, but it has started to improve. Mr Leach says: "We have spent a fair amount of time trying to get our positioning and imaging right, and [to get] people to trust us, to know that we are not in it for the short term."

This long-term commitment is underlined by the fact that IIBU is to launch itself as a separate company from The United Bank of Kuwait in the summer. It will then be known as Al Manzil Islamic Financial Services, and hopes to offer a range of Islamic finance products to parallel what is available from high street banks. Its products will be marketed through independent financial advisers, and it is organising seminars to brief them.

But opinions on the eventual popularity of these products vary. Syed Junaid Ahmad, senior partner at Unicorn Independent Financial Advisers, does not believe that the take-up rate will be very high. "About 90 per cent of the Muslims have succumbed to the idea that [paying interest] is something that they will just have to live with, and God will forgive them for taking a mortgage where they are paying interest. So they will stick it out."

But IIBU may soon have some competition. Another company that hopes to launch a Muslim mortgage is a Geneva-based Islamic financial services company called Dar al-Maal al-Islami Trust. It hopes to launch a Muslim mortgage through one of its subsidiaries, which will be marketed in Britain through its UK arm, Takafol UK. It currently offers an Islamic saving and investment plan, with some life assurance, and it has submitted plans for a Muslim mortgage to its Sharia'a board.

Mohammed Aslam, general manager, Takafol UK says: "[The Sharia'a board] are still considering it. We haven't developed an Islamic mortgage itself, but we hope to do mortgages eventually. We want to expand and to have more products that the Islamic market demands."

Alison Steed is assistant features editor at `Financial Adviser'.

`The Independent' has published a 36-page `Guide to Mortgages' on almost every aspect of home loans. For your free copy, sponsored by First Active, the flexible mortgage company, call 0800 550551