Guide for Innovative Finance ISA

An Innovative Finance ISA is a type of investment that can be made through a peer to peer lending platform in a tax-free wrapper. Any interest that you earn through this investment is never taxed, and it doesn’t count towards your Personal Savings Allowance. There is a limit on how much you can invest in ISAs per year, also known as an annual ISA limit, which is £20,000 for 2020. You can invest the allowance completely in IFISA, or you can spread it across different ISA types.

Also, you can transfer your existing ISA funds into an innovative finance ISA. Any savings from the previous year doesn’t count toward the current year’s annual ISA allowance, so it is an excellent way to raise your investment and maximise the returns. This type of investment is great for generating savings especially for those who don’t have any previous savings.

Further, IFISA is an alternative to traditional investment. Conventionally, if you wanted to invest tax-free and save, you would have to accept a low-interest rate of traditional cash ISA or invest in risky stocks and shares ISA. The IFISA is provided by peer to peer lending, which is considered less risky than the conventional stock market investments. Also, the interest rate is higher compared to the classic cash ISA. These savings don’t have protection of FSCS (Financial Services Compensation Scheme).

Benefits and Drawbacks of an Innovative Finance ISA

Just like other types of investments, IFISA has its own pros and cons.

Benefits 

• The set up is straightforward
• You can get a high-interest rate
• The interest has a tax-free wrapper
• You support entrepreneurs and small businesses through your investment

Drawbacks

• There is a risk of losing money since the funds are not protected by FSCS
• Default rates can be steep in an economic downturn
• Different factors like bad debts and liquidity can affect the interest rates
• The first £1,000 of interest earned on your investment is tax-free. If you make modest amounts, then the tax-free wrapper will make no difference.

Who provides IFISAs?

There are a lot of Innovative Finance ISAs providers available in the market. To provide this service, every provider needs to be authorised by the Financial Conduct Authority (FCA). This type of investments is highly diverse, and as the industry evolves, the range of choices available for investors is set to increase. Most providers specialise in some type of p2p lending loan, therefore, the type of loan and rate varies from provider to provider. For instance, if a IFISA provider offers a high-interest rate, they may be making risky investments or they might not diversify your money across different loans.

Some of the common loan types that p2p providers specialise in are:

• Consumer loans: most peer to peer lenders offer unsecured loans to consumers, and the investment is typically diversified across different loans. The market for these loans is very stable.
• Property loans:some P2P lenders provider property loans that vary in risk from project to project. For example, the buy-to-let includes less risk than funding a property development from scratch. Typically, these loans are secured against a property, but diversification is not the same as with consumer loans.
• Business loans:some providers lend loans to businesses; these loans might be secured or unsecured. The interest rates for these loans can be high, often because they are available to companies that have a risk of default. Some level of diversification is possible but is not the same as with consumer loans.

Just like any other type of investment, IFISA involves risk such as the borrower can default, or the platform could become bankrupt. Also, as mentioned above these loans are not covered by the FSCS. However, every platform has to have a wind-down arrangement in place, and the majority of them have some backup service providers who can manage loans in case the provider goes out of business.

If you are looking for an alternative investment opportunity which is less risky and low maintenance, then an Innovative Finance ISA can be an ideal option for you. It is also a good idea if you have savings that you can use get a better return, with low-interest rates.