Innovative Finance ISAs (IFISA) quietly hit the market a few years ago – but what are they, and could they beat the returns you get in your cash ISA?
From the basic concept to the potential returns, here’s everything you need to know about investing in an IFISA.
- What is an IFISA?
- Is your money safe?
- How much can you pay in each year?
- Are the returns really that good?
- What the experts say
- IFISAs and their typical returns
- How to choose the best IFISA for you
- Got more than £20,000 to invest this year?
- Are other investment types better?
An Innovative Finance ISA lets you invest in peer-to-peer lending opportunities within the tax-free wrapper of an ISA product.
Peer-to-peer (P2P) lending is where investors – like you – lend money to businesses who might not qualify for traditional commercial loans. If, for example, they’re a small business in need of just a few thousand pounds, many banks won’t lend because it’s not commercially viable for them (they won’t make a big profit).
Sometimes, it’s new businesses that need a cash injection. Banks can be wary of new businesses who can’t prove a track record of earnings. P2P platforms give them the chance
to raise the cash they need to start a project or launch a business.
As an investor, you lend your cash via the P2P platform. At the end of the investment term, your stake is returned and you also get paid interest. This interest is often more than you can earn in other investments.
Your cash is not FSCS protected once it is lent out, although, for most of the platforms, it is covered while the money is on deposit waiting to be lent.
Even if it’s in an ISA, if the business you lend to defaults, then you are not entitled to compensation. This, however, is very much like investing in a stocks and shares ISA: the amount you put in might not be the amount returned.
With some platforms, if a borrower defaults they will make up the difference from a special fund they hold separately (see below).
You can only open an IFISA through an FCA-approved organisation, though. That means they’re regulated – so you’re not going to open an account, invest, and have charlatans run away with your cash. It’s a legitimate financial product that has to meet strict legislation.
Some P2P platforms, like Lending Works, Zopa and Ratesetter, offer some protection against defaults. They have a ‘slush fund’ which will pay back your money if a lender defaults (though not the interest you would have received).
You’ll need to research each platform that interests you to see what type of protection (if any) they offer against losses.
You’re restricted by the annual personal ISA allowance of £20,000. So, you can either pay your full £20,000 into your IFISA in a tax year, or split it across other ISA products like a stocks and shares ISA and a cash Lifetime ISA.
You can only open one IFISA each year – but there’s nothing stopping you from opening a new one each year. You might find the rates better with different providers or you might just like to spread your money across different companies and different types of investments (e.g. one year put it into a platform that lends out generally, the next year in one that lends only on property and the third year in one that lends only to businesses).
Transfer existing ISA savings
Also, if you want to open a new IFISA, you can usually transfer your existing IFISA savings into the new account without affecting your £20,000 allowance.
You can also transfer savings from an existing cash ISA or equities ISA that you paid into in previous years. Whatever you do, don’t take the cash out of your other ISAs then pay it into your new IFISA! This counts towards your current annual allowance. Instead, complete a transfer form with the new platform you want to invest with so that they transfer the money direct and doesn’t eat into your current annual allowance.
Anything you pay in this year is part of your current personal allowance. The personal allowance covers money you pay in from April 6th to April 5th.
Yes and no.
The risk is higher than putting your money into a cash ISA. You could lose money rather than grow your wealth.
The risk is usually worth it when you consider the cash ISA alternative. The highest cash ISA interest rate on the market at the moment is a measly 1.91% – and that’s for locking your money away for at least five years.
An IFISA is at least a medium-term financial plan: you have to commit to lending your cash out for a minimum period. But you’re likely to see returns around the 6% mark for the same five-year term as a cash ISA.
Don’t forget, too, that leaving your savings in a cash ISA is letting inflation eat into your money. That means you’ll have LESS in real spending power as the years go on – not more!
Jasmine has spoken out against cash ISAs since the dawn of Moneymagpie – and has used IFISAs herself.
Jasmine says: “Instead of cash ISAs, I recommend setting up an equities ISA first. If you’ve got a decent amount in your equities ISAs, then you can look at investing in IFISAs.”
Founder and Managing Director of Sourced Capital, Stephen Moss, says of the shift away from cash ISAs to IFISAs:
“The cost of borrowing money has remained very favourable pretty much since the financial crisis and this has helped to stimulate consumer spending while also giving a boost to a property market that was otherwise brought to its knees.
“However, a consistently low rate of interest hasn’t been welcomed by those who have seen the interest paid on their savings pots all but fade away.
“A direct consequence of this is that the once popular investment option of a Cash ISA has seen a consistent decline, while more lucrative options such as finance innovation ISAs [IFISAs] have grown in popularity.
“These allow investors to make peer-to-peer lending investments, with any interest earned remaining tax-free, and not only does this not count towards your £1,000 Personal Savings Allowance, but the majority of platforms offer rates way above and beyond that of the conventional Cash ISA.
“It’s no wonder then, that there has been an exodus of investors drawing their finances from Cash ISAs to such an extent that even the biggest lenders are struggling to cope with the paperwork.”
If you’re starting to think an innovative finance ISA is an option for you, take a look at these providers.
- Funding Circle – up to 6.5% projected return
- Ratesetter – up to 4% projected return
- Zopa – up to 6% projected return
- Lending Works – up to 5.4% projected return
- Lending Crowd – varied returns (see below)
Some providers offer higher returns for more risk. For example, Lending Crowd has a fixed rate option with a projected return of 3.54%. But you could opt for the self-select option and choose how much to charge – up to 14.25% – on your loans. The catch? You’re taking the brunt of the risk – if people default, you won’t get your cash back.
Like any investment, there are no hard and fast rules for choosing the right IFISA for you.
Here are a few points to consider though:
- Go for a company that has a history. The peer-to-peer sector is still quite new and many names have come and gone even in the couple of decades that it has been operating. If you haven’t invested in a peer-to-peer platform before, it’s probably worth going for a name that has been around for a while like Zopa, Ratesetter or Funding Circle.
- Make sure they are FCA approved. This is crucial, as mentioned above. You need to know that you are investing with a company that is regulated.
- Read reviews and articles about the company you like the look of. There is a lot on the internet about peer-to-peer companies so see how other investors feel about the company you are looking at.
If you’ve got more than £20,000 to invest this year, you could look at P2P lending outside of your IFISA wrapper.
Property platform Blend Network offers potential returns of up to 12%. Property investment network British Pearl offer returns around 4.4% – or up to 11% (projected) if you opt to buy shares in their properties as part of your investment.
However, your money isn’t protected under FSCS and you also won’t get the tax-free benefits on your profits.
These platforms are worth considering once you have a decent amount of cash invested in more stable and time-tested products such as pensions and stocks and shares funds.
As Jasmine pointed out above, you need to have a solid financial base in other investments like equities ISAs before turning to P2P lending and IFISAs.
Equities ISAs spread the risk across several markets – whereas P2P lending is often very focussed on property, construction, and other commercial real estate activities. It’s also dependent on individuals and small businesses repaying their loans – rather than spreading risk across potentially hundreds of stocks in global markets.
Try Index Tracker Funds
An IFISA should be one strand of your larger financial strategy. Once you’ve got your stocks and shares ISAs up and running, an IFISA adds another potential revenue stream.
There are other ways to invest your money, too, that could grow your wealth much faster than leaving your savings stagnant in a cash ISA.
Index tracker funds are a popular choice for investors as they’re easy to use, offer fairly reliable long-term returns, and are less risky than investing in individual shares. They’re also cheap: there’s not very much hands-on work required by the fund provider, which lowers costs for the investor.