What is an Islamic loan?
Key takeaways
Islamic loans, also known as Sharia-compliant loans, adhere to principles based on Islamic law (Sharia)
You will need to demonstrate the ability to repay the loan (steady income, debt management)
The UK’s Islamic finance sector operates under general legislation applicable to all sectors
Islamic finance in the UK has experienced significant growth over the years, making it one of the leading hubs for Sharia-compliant financial products in the Western world.
Islamic finance, also known as Sharia-compliant finance, is a separate financial system that operates in accordance with Islamic principles and law, known as Sharia.
The development of Islamic finance in the UK can be traced back to the 1980s, when the first Western Islamic banks and financial institutions were established.
Since then, the industry has expanded significantly and now offers a wide range of products as well as services that cater to the needs of both Muslims and non-Muslims alike.
What is an Islamic loan?
An Islamic loan is one that is compliant with Sharia law and means that there is no payment of interest on the loan, as it is forbidden in Sharia law.
Islamic loans adhere to Sharia guidelines and principles which promote ethical and socially responsible financing. This means that they avoid and often do not permit any funding to industries like alcohol, gambling, and tobacco, which are seen as harmful to society.
How do Islamic loans differ from conventional loans?
Islamic banking recognises loans as non-commercial and excludes them from the domain of commercial transactions. Any loan given by Islamic banks must be interest-free. This is because in Islam, usury (charging interest) is seen as fundamentally unjust and unfair.
With conventional UK banks and loans companies, money is treated as a commodity and is lent against interest as its compensation.
Conversely, Islamic banking products are usually asset-backed and usually involve trading assets, renting of assets and participation on a profit and loss basis. This principle is known as Murabaha.
How does Murabaha work with Islamic loans?
Murabaha financing, sometimes known as cost-plus financing, takes the place of interest in Islamic finance.
Typically what happens is that buyer and seller agree the cost and mark-up of an asset, which the lender then buys on their behalf. The markup will be a set fee, which means that a Murabaha loan is not classed as interest bearing.
The Islamic Bank then issues a contract which outlines the cost and profit for the purchase, along with a repayment plan in monthly instalments.
What are the principles of Islamic finance?
An important principle of Islamic finance is that the loaned capital should not be used to cause harm.
For this reason, Islamic finance should not invest in things like gambling, arms, tobacco, and alcohol.
Islamic finance is guided by Islamic law, also known as Sharia. This law focuses on ethical financial practices. The most common features and principles that govern Islamic finance are:
The investment must not be in any businesses that are deemed not Sharia-compliant or unethical, such as pork products, alcohol, gambling, pornography, or weapons.
The loan cannot involve the payment of any interest. Interest-bearing loans are forbidden in Islam
The risk must be shared between at least two parties.
A ban on contracts with excessive risk or uncertainty.
What are the eligibility criteria for Islamic loans?
The eligibility criteria for an Islamic loan in the UK will vary depending on your chosen lender. However, there are common factors that most lenders adhere to when they pick a legible candidate, these include:
Credit history: Similar to other loan processes, you’ll need a good credit history to demonstrate a strong ability to pay back the loan. This will involve showing a steady income and the ability to manage existing debts.
Religious requirement: While Islamic loans are based on Islamic principles, most lenders do not require you to be Muslim to qualify for the loan, while other do have it as a requirement.
Purpose of the loan: The purpose of the loan should be compliant with Sharia law. This means it should not be used for any activities that are prohibited in Islam.
Minimum income: Some lenders have an income requirement
Loan amount: Some lenders may have a minimum loan amount you need to borrow
What are the benefits of Islamic loans?
Islamic loans allow you to take out a loan that can be entrusted to be in line with Sharia law. They are also seen as ethical, as Islamic loans typically avoid any financial activities that are deemed unethical or harmful.
Islamic loans offer a unique financial solution for those seeking sharia-compliant options, with transparent structures and potential for shared risk as well as ethical considerations.
It is crucial to be aware of the specific terms and conditions of your loan. Although you won’t need to pay interest on your Islamic loan, your loan may be subject to additional fees to cover additional costs and checks.
As the Islamic finance sector in the UK is still developing, the variety of products and lenders available may be smaller compared to other conventional options.
However, it is always worth comparing different lenders to find out the best product option for you.
Looking to buy a house in a Shariah-compliant way? Read our guide to Islamic mortgages and Halal home purchasing to get up to speed.
Is Islamic Finance regulated?
Yes, the Islamic finance sector in the UK operates under legislation that applies to all sectors.
Can Muslims use student loans for tuition fees?
Student loans are interest bearing. As a result, they're deemed non Shariah compliant.
However, the government is drawing plans for student finance products that don't require payment of interest and is compliant with Shariah principles. This is to be known as alternative student finance
These loans will afford Muslim students help with tuition fees if required, which they can repay when they complete their studies.
The contributions they make will only be used to fund future students who access alternative student finance.
MoneySuperMarket is a credit broker – this means we’ll show you products offered by lenders. We never take a fee from customers for this broking service. Instead, we are usually paid a fee by the lenders – though the size of that payment doesn’t affect how we show products to customers.
