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Innovative Finance ISAs – how do they work?

The Innovative Finance ISA allows you to lend your money to people and companies that are trying to raise cash. Often marketed as yielding greater returns than many other investments, they are certainly not without their risks. So it’s worth being clued up and knowing what you’re getting into.

Want to know everything about ISAs and the other types available? Check out our Ultimate ISA Guide to Powerful Tax-free Savings.

  1. What is Innovative Finance ISA?
  2. How does it work?
  3. What are the risks?
  4. Can I have a Cash ISA and Innovative Finance ISA?
  5. Innovative ISA Allowance 2019/20
 

What is an Innovative Finance ISA?

Innovative Finance ISAs (or IFISAs) were introduced in February 2016. Essentially, it is a way of directly lending your money to people or companies that are looking to borrow. For that reason, it’s referred to as ‘peer-to-peer‘ lending or loan-based crowdfunding.

The idea is that it cuts out the ‘middle man’, the broker, that usually takes their commission. As a result, the borrowers should pay less interest and the lenders (you) make higher returns.

In theory, everyone comes out winning, with returns often being suggested at 8-9% or more. But like most things in life, with greater reward comes increased risk.

The main benefit of this type of lending being wrapped inside an ISA is that whatever returns you make, you won’t pay any tax.

 

How does it work?

Peer-to-peer lending providers are FCA regulated and approved websites that facilitate loan-based crowdfunding.

You can pick from three main categories of borrowers:

1.Personal loans

2.Business loans

3.Property

You can also ‘invest’ in a business by buying their bad debt. With debt security crowdfunding, like bonds, you receive a set interest rate over a fixed period. And because it is through an ISA, the returns are tax-free.

Just because peer-to-peer platforms are FCA approved, doesn’t mean your funds are protected by the FSCS (Financial Services Compensation Scheme), because unlike other forms of ISA, they’re not.

 

What are the risks?

The Financial Conduct Authority (FCA) views Crowdfunding as a ‘high-risk investment activity’. In their view, consumers looking to invest in peer-to-peer lending should proceed with caution. There are some key risks to be aware of, including:

  • Capital is at risk – like all investments, you should only put in what you can afford to lose. With peer-to-peer lending, your entire capital is at risk.
  • No FSCS protection – unlike other ISAs, you will have no access to the Financial Services Compensation Scheme.
  • Reserve funds – many platforms have these protection mechanisms in place. However, they are voluntary, the policy can change at any time and they are no guarantee of protecting your investment.
  • Risk bandings – are used to help guide investors, but there are no standardised criteria so it can be difficult to compare platforms.
  • Accessing funds – you may not be able to get at your funds quickly, as there could be terms and conditions to which you are bound. Even if you can, you may get back less than you put in and likely to be fees to consider.
 

Can I have a Cash ISA and Innovative Finance ISA?

Yes, you can hold different types of ISA at one time.

Importantly though, you can only pay into one ISA of each type in a single tax year.

For example, you can pay into both an Innovative Finance ISA and a Cash ISA. But you cannot pay into two Innovative Finance ISAs during a single tax year.

 

Innovative ISA Allowance 2021/22

In the tax year 2021/22, the amount you can save across all of your ISAs remains at £20,000.

Remember, this goes across all of your ISAs. So if you have already put £10,000 in your Cash ISA, for example, then you only have £10,000 to put in your Innovative Finance ISA.

It’s easy to get excited by the potential returns that are touted by the providers. But it would be unwise to ignore the fact that the FCA recommends proceeding with caution. Lots of research and due diligence is definitely the order of the day when considering Innovative Finance ISAs.

 

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EatSleepMoney.co.uk does not offer financial advice and is intended for reference/information only. Remember, you should always carry out your own research and/or take specific professional advice before choosing any financial products or services or undertaking any business or financial venture. Investments may go up as well as down and you may get back less than you put in.

 

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