We’ve all heard the debate: “Call it riba or rent - it's all the same isn't it?” And the more savvy among us will have explored most of the familiar lines of rebuttal too: “we live in an interest-based financial system – there’s only so much you can do” or “no there’s true risk-sharing – that’s what makes this halal.”
But what actually happens behind the scenes in these banks and financial institutions? And is a “truly” Islamic mortgage that is also regulated and scaleable actually possible? And can Islamic mortgages ever get as affordable as mainstream mortgages?
Well, recently, through our investment platform Cur8 Capital we decided, in typically understated fashion, “let’s actually see if we can solve this dinner-time debate once and for all.”
For those who are now hopelessly trained on the Tiktok algorithm and can’t muster the energy to read words anymore, the summary of the entire article is:
- Building Islamic mortgage products is indeed very hard in a financial system based on interest. We will lift the veil on how it is done so you properly understand where the truth, lies, ambiguity and commercial interests are in this debate.
- Building a risk-sharing Islamic mortgage product is possible though – but needs a real will to do that. The easier way is always to just go with what already exists.
- The source of money that you get the investment from to deploy into Islamic mortgages is of vital importance. Retail investors are expensive (you need to give them higher returns) while institutional investors are cheaper.
- We currently have a narrow window as a community to ramp up the Cur8 Fixed Income fund fast to £10m using retail money – as currently interest rates are high – when they drop we need to switch to institutional money to keep our Islamic mortgages affordable.
- In order to get institutional funders we need to have grown the fund to a size that an institutional investor will invest in.
- So the TLDR of the TLDR is, folks, you now have a solution that can potentially end the Islamic home finance issues for Muslims in the UK once and for all within the next 3 years. You just need to invest when the Fixed Income Fund goes live and get around 6% per annum.
We structure the article as follows:
- Problem & Audience
- Solution & Partners
- The Ugly Bits
- Scaleability & Long term vision
- Marketing & Distribution
We try to be as painfully transparent in this article as we can be – having run this gauntlet over the last few months what we’ve come to realise is that the financial system is full of smokes and mirrors and ambiguity – usually as there’s money involved. And that opaqueness is what causes so much of that discontent.
We will also include the bits about the product we’re not entirely happy about too just so you understand why compromises are made.
Problem & Audience
Like good product people that we are, the first thing to do before building anything is to identify the problem and who you are solving it for.
The problem we’re trying to solve is actually two-sided - on one side you have people seeking finance and on the other side you have investors seeking a regular return backed by property.
The finance-seeker’s problem is threefold:
- He wants to find a "truly" Islamic mortgage that shares risk with him.
- Islamic finance is more expensive than conventional finance.
- There isn’t enough Islamic finance to go around. People get old and die before they get through an application right now. Applying for an Islamic mortgage actually increases your eman as you have to think about death.
The investor’s problems are:
- There isn’t a high-yielding product that allows him to invest in residential home finance. Islamic banks offer a nice rate but it's still below 5%.
- There are high-yielding investments based on commercial finance - however pooled vehicles for this are hard to come by – and they do come with higher risk.
- There are a number of property-linked investments out there, but they’re offered by unregulated firms - some run by the Salman Bankman-Frieds of the world – some run by legitimate people – and it’s easier to just avoid it.
This articulation of the problem is vital if you are to come up with a financial product that is genuinely compelling. A truly compelling product hits most if not all of those pain points.
Solution & Partners
Our solution plays to our strengths and looks to solve the majority of the problems we identified. The solution is actually two-fold too:
Solution Part 1
First you need to get the money to do anything. That’s fine, we are an FCA-regulated fund manager so we can spin up a fund. But for that to get going you need investors. And for investors you need a compelling financial return.
Most Muslim investors we know don’t get out of bed for anything less than 5% return. But the core equation then doesn’t add up:
Right now conventional mortgages are around the 4-5% interest rate – and if we truly have the ambition of getting Islamic mortgages to that amount and also make at least some margin and cover partner costs – we’re going to have to offer the Islamic mortgage out at at least 6%+.
So what do you do?
Well this is where the first core innovation comes in. You see, there are higher yielding Islamic products out there – also backed by property. These are products like bridge financing, property development finance, and even buy-to-let finance. There are companies like Offa and Nester that offer these and returns range from 7-9%.
So if you take £100 and blend the investment across:
- Islamic mortgages; and
- Bridge finance
You can actually end up with a blended return to investors of 6% and still drive down the Islamic mortgage rates you charge to the home buyers on the other end.
But if you really want to drive down prices (to 5%) – and you can’t scrimp on investor payout (6%) – the reality is that you can only charge wafer thin fees even after blending in bridge finance returns. As we’re an impact-focused commercial operation we will of course be doing this in order to unlock the potential of our community inshAllah.
There is a fiqh compromise you are making here by the way – more on that later.
The crucial thing with all this structuring is that you want to make sure your investment is properly backed by security at each turn – because ultimately there is a property here – so by taking security you will significantly reduce your downside risk in case of any default.
So Solution Part 1 is summarised as:
- Set up a fund.
- Make sure you partner with both regulated Islamic mortgage and bridge finance providers. We will partner with Offa in the first instance, shortly followed (inshAllah) by Nester.
- Offer a decent, property-backed return to investors by blending the two pots together.
- Make sure your investments are fully backed by property at each stage.
Solution Part 2
Solution 1 on its own is fine – we achieve status quo on Islamic mortgages – but with a higher return for investors.
But we don’t want just that, we want a “truly” Islamic mortgage. That’s where the fun and games start.
First, what is a “truly” Islamic mortgage?
Well the core concern with an Islamic mortgage (or HPP) today is that it is too much like a debt product:
- You are locked into buying the entire house from the bank from day one; and
- The bank doesn’t share in the upside or downside with you.
Now an aside: we think these issues are largely academic in reality. The average home buyer will switch his mortgage in 7 years anyway, so mortgages rarely get to term when the "bite" of the "you are locked into buying the house from the start" issue kicks in. Secondly, and most importantly, 99% of home buyers actually want to buy the entire house. The clue is in the name "home buyer".
But having said that, if we can lean in and solve this wrinkle, then all things considered, that is better.
So in order to try to address those concerns we need to come up with a product that doesn’t lock a customer in to buying the entire house from the bank from day one and where the bank can share in the equity upside and downside. Beautiful.
Not so fast.
First, the “Home Purchase Plan” is the regulated product that the government allow as an Islamic mortgage today. Under a HPP a financial institution can actually own a house and, once all payments have been made by the home buyer, then transfer the home to the home buyer – all without paying stamp duty land tax twice and without rent being treated as VATable.
The tax bits are pretty important – without those – the product becomes uncommercial. But there is a catch – with a HPP you must legally be in an agreement to purchase the entire portion of the HPP financing off the bank by the end of the term.
(Side note: we assume the government stipulated this because they don’t want the HPP structure to be abused by people who are just property developers, landlords etc. who use it to avoid stamp duty. We also assume the government did this in order for the HPP to not require extensive amendments to the copious amounts of financial regulatory law around mortgages and securitisation (because that would be very difficult and there would be no political will to do it.))
All this means that you can’t just buy a house as a landlord, and then sell it to your home purchaser at the end of an undefined term. This would be an unregulated product as it would not qualify as a HPP (and we’ll talk more about why regulated products are important), it would suffer from taxation issues, and it would struggle to scale.
So what we have come up with, in collaboration with Strideup, is a product that works thus:
Let’s say you want to buy a house for £100k and have a £20k deposit. Usually a HPP would require you to agree to purchase the £80k over a period of 25 years, at the same price as day one. You simply have to do that. This is how the split looks (under an Islamic bank like Gatehouse, say):
£20k – deposit
£80k – HPP buy-back portion
Then Strideup came along with their twist on the HPP:
Now you only have to buy back £60k of the house. £20k you can buy back if you want to, but you don’t have to buy that. This is how it looks:
£20k – deposit
£60k – HPP buy-back portion
£20k – Strideup’s Equity Share
With Strideup’s equity share they share in the downside risk on their £20k, but if there is any upside you keep that. If you haven’t bought their £20k out by the time the 25 years is up, you have to buy them out, or look to sell the house to pay them off.
This is a great product to be honest – and we could have stopped there – but we decided to give people a choice of another product too:
Under this new product offered through the Cur8 funding (let’s call it the “Cur8 Product”), you still have your £20k deposit, and there is still a buy-back portion, but now the Equity share shares in both the upside and the downside.
So this might seem worse than Strideup’s original product. But there is a key difference. We would allow home buyers to increase our equity share to 40% and we would charge half the rent on this Equity share. So from a monthly cashflow perspective this can be a game-changer for some.
We also plan to introduce in the concept of rental holidays 5 times in the first 5 years – which you can pay for using built up equity – again making the product more affordable and lenient for buyers.
So this now looks like this:
£20k – deposit
£60k – HPP buy-back portion
£20k – Strideup’s Equity Share (upside and downside risk, with reduced rental)
There, we’re done.
Phew, for the five people who are still with me at this point, you’ll appreciate the incredibly intricate dance that has to be played out incorporating:
- Tax and regulatory issues
- Commercial interests – “guys, can we actually make this work other than as a charitable project?”
- Fiqh issues
- Partnership issues
The Ugly Bits
So far, we are aware that this article has been a backslapping fest of “look at us, aren’t we legends?” Well, let’s share with you the bits we’re not that happy about too. This happens with every financial product by the way – most people just don’t tell you.
The first compromise we have had to make – at least for now – is that only sophisticated and High Net Worth investors can invest in the Fixed Income Fund. As we are a regulated fund manager, when we offer private funds, we are bound by regulation which seeks to protect investors.
Our plan to address this is to scale the product north of £10m, after which we can explore making it a publicly listed vehicle.
The second compromise is that we won’t be able to offer our Cur8 Product from day one. Commercially it doesn’t work for Strideup to offer a product like that until we have scaled to at least £3m. But once we’ve scaled, we can inshAllah roll this out.
The third compromise is that when it comes to the underlying product that the bridge finance providers use – it will be the commodity Murabaha product.
This is a product common across all of Islamic finance today and signed off by the most prominent Islamic finance scholars – but we have been reluctant about using it unless there is a genuine need to use it. This is not the article to go into why – but in a nutshell we think the product doesn’t progress the industry to a place we believe that we should be driving to.
We think the UK situation means that commodity Murabaha is the only viable product to use in a bridge financing context unfortunately. Bridge financing and other commercial finance transactions like it are not regulated and do not benefit from the HPP taxation exemptions and as such it’s just not commercially viable to do an Islamic deal any other way.
The way we got comfortable with this was because there is now an active move in the industry and lobbying with the government – led by Nester – that will hopefully help pave the way to allow for other types of Islamic financial products that everyone is comfortable with.
Scaleability & Long Term Vision
Because conventional interest rates are so high – they and rental rates are actually quite similar right now. That means that for Islamic mortgages there is a narrow window where, if things are structured the right way, the Cur8 Fixed Income Fund could actually drive Islamic mortgages down to somewhere near the mainstream mortgage rates.
But that won’t last – interest rates will fall – and then Islamic mortgages won’t be able to compete anymore as their source of funding is not the interest-based money markets but investors. And investors want the rates to stay above 5% regardless.
So at that point, you need institutional capital (e.g. £200m), as that is more patient and happy to take a lower return. But to get institutional capital you need to have at least some track record – at least £10m worth of it.
So we as a community have a narrow window to get to £10m in this fund, and then we (Cur8) can do the rest. Once you have institutional capital you can do a lot of home financings with that and really scale it.
The long term vision with this fund and with the Cur8 Product is to offer something that is so compelling that not just Muslims use it, but the entire mortgage market takes note of what the Islamic finance industry has contributed.
We want to work with the various other players in the home financing space too – Primary Finance, Wayhome, Heylo etc. – we will always partner with experts to issue the home financing as we want to stick to what we know best - fund management. This is the wonderful thing about this Fund if done right – it has a power of helping many flowers bloom.
Marketing & Distribution
Articles like this can hopefully raise awareness of the project we’ve launched – please do share this far and wide – especially those who are exploring investment options.
If you would like us to come and speak in your local area we are more than happy to do that too.
We will also be doing a Youtube video on the product as well and on the Cur8 Capital platform we will have a detailed video about the product, including interviews with our partners Strideup and Offa.
Make sure you’re signed up onto the Cur8 platform so you are kept in the loop on the Cur8 Fixed Income Fund as soon as it launches. We are also pleased to announced that we already have pre-commitments north of £1m – and the thing hasn’t even formally launched yet alhamdulilah.
Finally, if you can do nothing else, just make dua for this project.