Innovative Finance ISAs are now available – and they’ve got savers excited. Promising around double the interest of the best cash ISAs, they allow tax-free investment in peer-to-peer lending. Are they what we’ve all been waiting for?
Lately we have seen a flurry of developments on the ISA front. In April of this year we will see the arrival of the Lifetime ISA, designed to help people save both for a first home and for retirement, and there will also be a dramatic raising of the ISA annual limit, to £20,000 in 2017-18. One of the reasons for this much more generous limit is that there are now far more ISAs around than there used to be. Another exciting new kid on the block is the Innovative Finance ISA.
So what is it? More importantly, how good is it? Let’s take a look.
A whole new kind of ISA
The Innovative Finance ISA is a new breed of ISA, falling somewhere between a cash ISA and a stocks & shares ISA. It lets you loan your money out through peer-to-peer (P2P) lending and pay no tax on the interest.
P2P lending platforms allow people to lend money directly to one another. It is generally described as ‘lending’ rather than saving or investing, but for the lender it works much like a fixed-interest investment. Because the platform is the only ‘middle-man’ and a bank is not involved, the lender/investor can enjoy a higher rate of interest. Typical rates range from over 3 per cent for short-term loans to over 6 per cent for loans lasting several years.
An Innovative Finance ISA allows you to keep the loans you make in a tax wrapper, so that all the interest is tax-free (as in a cash ISA). You can open only one such ISA per year, but you can wrap up loans from more than one P2P lending platform in a single ISA. This is a useful feature (only recently added) as it will encourage competition between the P2P platforms and should mean interest rates remain attractive.
How much money can I put in this ISA?
The current ISA limit for 2016/17 is £15,240, split across all ISAs including cash, stocks & shares, Help-to-Buy, Lifetime ISA and Innovative Finance ISA. The total amount you pay into your ISAs each year can’t exceed £15,240 but if you want to, you can put the whole lot into one Innovative Finance ISA. From this April the ISA limit will rise to £20,000.
How do the P2P loans actually work?
When you become a lender, your money is either assigned to a specific borrower or split over several (depending on the platform you choose). Borrowers make regular monthly repayments, of which the platform takes a percentage and the rest goes to you.
What if they miss a payment or default?
P2P platforms are required to have a provision fund to reimburse lenders for their potential losses. FCA regulation requires this fund to be at least £50,000 by April 2017, but the most reputable lenders have much larger funds totally millions of pounds. This means that your capital sum (i.e. the money you originally lent) should be safe, and you should also receive your expected level of interest, even if your borrower were to cease repayment.
But there are still risks?
Yes. Although P2P lenders are FCA-regulated, our money is not guaranteed by the Financial Services Compensation Scheme. The only safeguard is the lender’s own provision fund. This means that, technically speaking, if enough borrowers were to default then the provision fund could be used up. In an extreme case, this could mean you losing not only your interest but all of your capital sum.
The biggest platforms such as Zopa, Ratesetter and Lending Works are quick to point out that so far none of their lenders has lost money with them.
Where does the Innovative Finance ISA fit in the ‘ISA zoo’?
In terms of risk versus potential reward, this ISA fits somewhere between the cash ISA and the stocks & shares ISA. The risks and returns are higher than you’d get from cash, but no so high as you might find (potentially) from stocks & shares. A stocks & shares ISA can fluctuate significantly in value and is of course directly affected by changes in the stock market; by contrast, although you can technically lose your investment in an Innovative Finance ISA, under normal conditions they deliver a steady return.
Are any another changes expected?
The Treasury may open up the Innovative Finance ISA to more types of ‘alternative’ investments in the future, such as crowdfunding. This offers the prospect of more diverse ISAs with a rich balance of risks and rewards. There are however no details on this as yet.
Is an Innovative Finance ISA the right choice for you?
The suitability of any savings or investments vehicle depends on your broader financial circumstances. Similarly, the choice about whether a long-term or short-term ISA is best for you can be quite complex. Talk to an independent financial adviser about how best to use your new expanded ISA allowance to its full potential.
The above article was first published by unbiased on the 2nd February 2017