Innovative Finance ISAs are a relatively new type of wrapper available through peer-to-peer (P2P) lending platforms.

This type of ISA lets P2P lenders enjoy tax-free returns as long as they don’t exceed the usual £20,000 ISA allowance.

With rates on offer as high as 6% or 7%, it’s easy to see why these products have caught the attention of long-suffering savers.

But it’s important to remember that rates are high because of the risks.

To re-cap, P2P lending platforms such as Zopa, Funding Circle and Ratesetter, match you the saver (or to be more accurate, the lender) with borrowers, which are either individuals, small businesses or both – depending on the platform.

However, you can also lend to property developers, wind farms or even more left-field sectors like pawnbroking.

The platform takes your money and allocates it to a range of different borrowers, with the aim of mitigating the risk of defaults.

Savers hope to get better rates than they would from banks and building societies, while borrowers aim to raise money for themselves or their business without having to go through the traditional bank route.

Over the last year, the amount of money saved in Innovative Finance ISAs – or IFISAs – has increased by over 700% with six times more people now saving in an IFISA, according to HMRC data.

The amount of money in IFISAs rose from £36m in 2016-17 to over £290m in 2017-18.

But it’s important for savers to fully understand the dangers before taking the plunge.

The risks

One of the main risks is your money is not protected by the Financial Services Compensation Scheme (FSCS) like it would be if you went for a traditional savings product. The FSCS entitles customers to compensation of up to £85,000 if an authorised financial services firm fails.

There’s also a risk you won’t get your money back or you could get it back later than expected. Although the different platforms have their own criteria for accepting individuals and/or firms to lend to, there’s no guarantee borrowers will be able to pay back the loans.

There is also the chance you may not get the advertised rate, for example if a single borrower fails to repay the money or if there are changes to macroeconomic conditions. However, most major platforms have provisions in place to protect savers.

If you’re comfortable with the risks, Andrew Hagger, an independent personal finance analyst from Moneycomms.co.uk, suggests the following checklist:

• Consider investing a small sum to start with to ensure you’re happy with how it all works.
• Check the provider website for details of the measures they take to protect your money. Most will have some sort of protection in the form of a provision fund.
• Check the minimum sum you can lend (it’s usually between £10 and £100 but some require £1,000).
• Find out the platform’s track record to date regarding defaults/losses. Look for actual figures rather than vague promises. RateSetter is an excellent example as it gives full details of its provision fund, including the amount set aside for defaults.
• Check if you are able to access your money if you need it in an emergency – some platforms operate a secondary market but check what this involves and if there are any charges.

Your money could boost small businesses

If you want to earn interest and help boost the UK economy at the same time, P2P lending could be a good fit (if you’re aware of the risks outlined above).

Funding Circle, one of the biggest P2P platforms, lends exclusively to small businesses. Between 2010 and 2017, the platform lent £3.4bn to UK firms.

One of these companies, Moo Free, was launched by husband and wife team Mike and Andrea Jessop at the end of 2010. They recognised a gap in the market for quality dairy and gluten free chocolate.

They borrowed through Funding Circle in 2013 and within four years of setting up, had won industry awards and begun exporting internationally.

Mike Jessop said: “If people lend us money it’s just an amazing thing they’ve done, and they probably don’t realise but the difference they make is massive. It’s a very ethical company, we would prefer members of the public to be benefiting from our success.”

Another business, north London-based Redemption Brewery, first borrowed through Funding Circle in 2016.

The firm said that as a manufacturing business, having access to unsecured funding gave it the flexibility it needed.

The company now brews 9,000 pints every day, three times more than with its previous brewery.