Peer-to-peer lending: Should you invest in an Innovative Finance ISA?
Every adult has a £20,000 ISA allowance each year. This is the maximum that can be saved or invested in an ISA with the returns tax-free.
You can save the full £20,000 in one ISA or split it between different types of ISA such as a cash ISA, stocks and shares ISA, and Innovative Finance ISA (IFISA).
An IFISA is a type of ISA where you don’t pay tax on interest made from peer-to-peer lending (P2P).
P2P lending works by matching up investors – who are willing to lend – with borrowers, who could be individuals, businesses, or property developers.
They appeal to investors who are willing to take on more risk with their cash for higher interest rates offered than typical savings accounts.
However, due to their growth amid the low-interest environment, they’ve increasingly come under the spotlight by the city regulator, the Financial Conduct Authority (FCA).
In 2019, it imposed stricter rules for P2P platforms to protect less experienced investors.
Under these rules ‘inexperienced investors’ are limited to putting in 10% of their investible assets in P2P. So, if you have £20,000 to invest in an ISA this year, that means you can only invest £2,000 in an IFISA.
Under marketing rules imposed by the regulator, P2P platforms can only target high-net worth or sophisticated investors with P2P investment deals, including ISAs.
It’s up to the P2P platform to evaluate whether an investor is ‘high net worth’ or ‘sophisticated’, but most people won’t fall into this category.
Which firms offer IFISAs?
Those choosing to invest in an IFISA would have previously looked to the big players in the P2P market: Funding Circle, Ratesetter and Zopa.
But all three firms have recently exited the market. Funding Circle is the latest to announce it is permanently closing its peer-to-peer business to retail investors. Ratesetter closed its loan portfolio after being bought by Metro Bank and Zopa shut down its P2P business to focus on being a digital bank.
Back in 2019, Landbay also pulled out of the retail P2P sector, returning all funds to investors.
So, without these big players in the market, is it still a good idea to have an IFISA as part of your ISA consideration? On the plus side, the rates on offer are undoubtedly attractive.
Kuflink is offering a five-year IFISA with a ‘target return’ of 7%. The money is lent to borrowers looking for short-term bridging finance for residential and commercial property investments. Loans are secured against UK property.
However, a warning on Kuflink’s site explains: “Securing investments against UK property does not guarantee that your investments will be repaid and returns may be delayed.”
EasyMoney is offering IFISA target returns of 5.02% for people willing to put their whole £20,000 allowance into its Tax-Free Premium Plus IFISA, which is backed by UK property. It says investors can ask to withdraw their cash at any time, but the small print warns that instant access is not guaranteed.
Other firms offering IFISAs include Assetz Capital which offers P2P loans to SMEs and property developers. Its Quick Access IFISA pays 3.75%, but it admits access to your cash isn’t guaranteed.
Another option is CrowdProperty which offers returns up to 8% backed up by charges against UK property.
If you want money in your IFISA to be lent to consumers, not property investors, there aren’t many options now that Zopa and Ratesetter have gone. Pretty much the only option is Fund Ourselves which offers IFISA returns up to 15%.
This might sound great, but bear in mind that the higher the rates offered on an IFISA, the riskier the person borrowing is likely to be and the greater chance they default on their payments.
Fund Ourselves offers payday-style loans to people with bad credit with typical rates of 505% APR. These borrowers will be desperate and at high risk of defaulting on their loans.
Is your money safe with a P2P lender?
If your cash is invested in a cash ISA with a bank or building society, it will be protected by the Financial Services Compensation Scheme (FSCS) up to £85,000 per person per institution.
If you have a stocks and shares ISA, you’ll be protected by the FSCS if your ISA provider goes bust, but you won’t be shielded from the ups and downs of the stock market – so your ISA could lose money.
It’s a similar set up with IFISAs. P2P platforms are obliged to ringfence their assets from investors’ money, so if a P2P platform went bust, investors should still receive their investment returns provided the loans don’t default. However, if borrowers do default on payments, there’s no protection in place and you could lose some or all of your money.
What do the experts say?
James Andrews, senior personal finance editor at money.co.uk, warns that investors need to be absolutely sure what they’re getting into with an IFISA.
He says: “These accounts are not savings accounts. Not only are returns not guaranteed, you could also lose some or all of the money you invest in them. Worse, they’re also not covered by the Financial Services Compensation Scheme (FSCS), meaning no guaranteed protection in the case your provider goes bust.
“The past two years problems have plagued the sector – seeing providers including Funding Secure go bust, other platforms struggle to find the cash for people looking to pull out of their investments and the original P2P platform Zopa deciding to stop offering peer-to-peer investments at all. So, while the returns may look attractive, be very sure you’re prepared to take the risks before transferring some of your money into an IFISA.”
Darren Cooke, chartered financial planner at Red Circle, also has concerns about IFISAs. He says no ordinary investor should have ever invested in P2P at all.
“They were often mis-marketed as low risk or secured investments paying fixed rates of return and made to look like higher interest bank accounts in some cases,” he says, “They were far from that in many cases. If a business can’t secure capital from a bank then there is a reason, and that reason is a higher risk of default.”