The Islamic mortgage market is set to grow by 47% a year and could be worth £1.4bn by 2009, market research group Datamonitor has said.
Islamic banking is expanding in the UK and set to grow further
There is a growing demand from the UK's 1.8 million Muslims for mortgages that comply with Sharia law.
The law forbids interest payments; in Islamic mortgages an intermediary buys the property for an interim period, and receives rent and other payments.
High Street banks HSBC and Lloyds TSB have begun to offer Islamic mortgages.
"The entrance of HSBC and Lloyds TSB marks a crucial milestone in the development of the Islamic mortgage market," said Maya Imberg, financial services analyst at Datamonitor and the report's author.
The two High Street banks' move into the market has made it far easier for consumers to access Islamic mortgages because HSBC and Lloyds TSB have extensive branch networks.
In 2003, there was only one bank offering Islamic mortgages in the UK.
There will be five by the end of 2005, including the Islamic Bank of Britain.
The current value of the Islamic mortgage market is £164m, Datamonitor said.
Datamonitor's prediction of fast growth for the Islamic mortgage marketplace is based on the spread of regulation.
How it works
Sharia-compliant products are based on Ijara and Murabaha methods.
Under an Ijara finance plan, the customer chooses the property and agrees a price with the vendor in the normal way.
The property is then purchased by the financier, who takes its legal title.
The property is then sold on to the customer at the original price, with payment spread over an agreed period of time.
During that time, the customer also pays the financier rent for the use of the property. Once the agreed period of time has elapsed, ownership of the property is transferred to the customer.
In many ways, this system resembles the leasehold system of buying property, with the crucial difference that at the end of the lease the tenant owns the property, not the freeholder.
At present, Ijara products are unregulated by the Financial Services Authority (FSA) and as a result mainstream lenders have steered clear.
However, following the findings of a Bank of England working party into Islamic finance, legislation that will lead to Ijara products falling under FSA regulation is expected soon.
"Lenders view this development as paramount to putting Islamic mortgages on an even plane with conventional mortgages," Ms Imberg said.
As for Murabaha based mortgages, the removal of double stamp duty in 2003 has boosted the market.
Under a Murabaha mortgage, the financier purchases the property from the vendor, but on the day of completion it is immediately sold on to the customer at a higher price. This led to the imposition of double stamp duty.