Specialist banks are aiming to broaden their appeal by offering an “ethical” way for people to purchase a house. Islamic mortgages have become a niche proposition since high street names HSBC and Lloyds Bank left the market more than five years ago, but specialist lenders are now looking to breathe new life into the sector.

Sharia-compliant mortgages typically work in the same way as traditional home loans. A bank helps finance the purchase of a property, with the customer making monthly payments until they own the whole property.

However, rather than an interest rate, a “rental rate” is charged on the part of the property owned by the bank. This is because interest cannot be charged under Islamic law.  Because of this difference, such arrangements are often called home purchase plans (HPP) rather than mortgages.

Gatehouse Bank has become the latest Islamic bank to enter the market. As well as targeting customers with religious requirements, it said it is trying to appeal to would-be homeowners tempted by “ethical” finance.  Charles Haresnape, of Gatehouse, said:

“We believe that Sharia finance, regardless of religion, is ethical finance. People want a good deal but they want to know it is ethical. We will not finance the arms trade, gambling or alcohol. No major banks can give those assurances. Young people are very conscious of these issues.”

Even with the attempts to court mainstream home buyers, mortgage brokers remain sceptical about whether Islamic finance will be able to take a significant share of the market.

The major drawback for customers is that the rental rate is usually higher than the interest rate on a traditional mortgage would be. Gatehouse Bank has launched with a two-year fixed-rate deal at 3.19pc. A high street mortgage lender would typically charge less than 2pc for a similar two-year deal. This reflects the higher cost of funding for Islamic banks. Mark Harris of SPF Private Clients, a mortgage broker, said:

“With the mortgage likely to be the biggest outgoing for many, rate is an important factor. If a deal is more expensive than alternatives on the market it will be a hard sell.”

Al Rayan Bank is thought to be the UK’s biggest Islamic finance provider. ABC International, Ahli United Bank and UBL are the other UK-registered banks to offer home purchase plans.

“It is a little-known market,” said Mr Haresnape. “But there are lots of similarities to shared ownership mortgages. You pay back capital each month but instead of paying interest you pay rent on the portion you don’t yet own. It is rental payment rather than interest.”

Mr Harris said that from a tax perspective stamp duty, capital gains tax and inheritance tax were treated in the same way as a traditional mortgage. Borrowers are also required to pass the same affordability tests to ensure they can meet their monthly payments.

Source Telegraph