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Page 1 of 5 Tariq Hameed analyses the most popular type of Islamic mortgage, the ‘Diminishing Musharaka’, and explains how it differs from conventional mortgages and its treatment from a tax and regulatory perspective
Since 2003, the government has introduced a number of measures equalising the tax treatment of Islamic mortgages with a view to creating a level playing field for financial institutions and customers. In 2007, secondary legislation bringing certain categories of Islamic mortgages into regulation will come into effect.
Islamic finance is perhaps one of the main emerging markets globally and the UK is no exception. Muslims constitute the second-largest faith group in Britain after Christians, and it is therefore unsurprising that Britain is one of the first Western states to have a detailed tax and regulatory regime addressing Islamic finance products. It is interesting to note that the progress made in Britain is more advanced than many countries with a Muslim-majority population. Many such countries are, as a consequence, following the experience of Britain in this regard.
Islamic mortgages
Over the last couple of years, a number of institutions have entered the market with often different or differing products. To an institutional newcomer, the variety of products and the level of complexity for particular products can be a steep learning curve. For customers, who have less financial sophistication than institutions, such variety and complexity can lead to scepticism and in some cases rejection.
Given the very specific prohibition of usury, or interest, in the Koran (the holy book of Islam), a financial institution cannot simply lend money with interest to its Muslim customers and must as a consequence devise new products that accommodate the rules, principles and parameters of Islamic law (i.e. Sharia). However, product development in Islamic finance should be undertaken with a degree of caution. Some institutions make the mistake of seeking to repackage existing interest-based products with an ‘Islamic character’. The more sophisticated financial institution recognises that Islamic finance is tangibly different from conventional finance and its resulting products are therefore really neither compliant with the spirit nor the letter of Sharia.
It is for this reason that many customers and scholars object to the term ‘Islamic mortgage’, since the concept of a ‘mortgage’ brings to mind a conventional mortgage and its inherent unfairness to defaulting borrowers. The government has, as a consequence, referred to ‘home purchase plans’ when referring to some types of Islamic mortgages.
Of the various home purchase plans, the most popular – and in the author’s view the closest so far to the spirit of Sharia – is the ‘Diminishing Musharaka’ product. There are other types (e.g. Murabaha (commonly referred to as a ‘trade with a mark-up’) or Ijara wa iqtina (leasing with a purchase option)) but this article will analyse the Diminishing Musharaka product.
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