Considering investing in an Innovative Finance ISA? Personal Loans Now takes a look at the pros and cons and the risks of using this ISA, helping you to make an informed decision.

Is it Worth Investing in an Innovative Finance ISA? Personal Loans Now

Learning Highlights
  • What an Innovative Finance ISA is
  • Weighing up the pros & cons of Innovative Finance ISAs
  • How risky Innovative Finance ISAs are
  • How to further reduce risk when investing in IFISAs
  • Conclusion

Although the creation of an Innovative Finance ISA was announced in 2015, the first products didn’t appear until April 2016. There are now a variety of IFISAs on offer, and this article has information and advice about putting your savings in this financial product. We explain what they are, how they work and their benefits. We compare them to cash ISAs so you can judge whether this is the best way to invest your money.

What is an Innovative Finance ISA?

An Innovative Finance ISA is very similar to crowdfunding and makes use of a peer-to-peer lending platform to connect borrowers and lenders. There are no middlemen (like banks or agents) taking their share of your profits and so all interest and capital is returned directly to the lender (apart from a small fee to the lending platform). Many of the borrowers are start-ups, but the list of clientele includes industries of all types ranging from property developers to funding for film or TV projects.

Innovative Finance ISAs are tax-free.  Personal Loans Now

Weighing Up the Pros & Cons of Innovative Finance ISAs

Personal Loans Now, a personal loans direct lender in the UK, takes a look at the advantages and disadvantages of IFISAs below.

The Benefits

Apart from paying no fees to middlemen, the projected returns from investing in IFISAs is significantly higher than Cash ISAs. Of the products on the market, the interest offered to investors varies from 3% to over 10%. This is at least three times the rate offered by Cash ISAs.

Another way that investors save is that the IFISAs are tax-free. As of April 2017, investors can invest up to £20,000 in P2P lending platforms, and they don’t need to pay tax on the interest they earn. This means that they don’t use up their £1,000 PSA (Personal Savings Allowance) for HMRC.

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The Drawbacks

When investing in P2P lending platforms, there is no guarantee that you will receive the percentage returns that they are quoting. It is quite possible that the borrower’s business doesn’t do as well as expected or even that they default on their unsecured loan.

Another problem is that IFISAs are not part of the Financial Services Compensation Scheme if the business goes bust. For savings, they will protect up to £85,000 whilst they will reimburse investments in stocks and shares up to £50,000. However, with innovative finance, you could lose some or even all of your investment and not be entitled to a penny’s compensation.

How Risky are Innovative Finance ISAs?

Although you aren’t entitled to compensation, peer-to-peer lending platforms are licensed and regulated by the FCA. To offer IFISAs, firms must also register themselves with HMRC as ISA managers. Both of these statutory obligations require firms to go through a rigorous application procedure. This was the chief reason why there were so many delays before IFISAs became widely available. Therefore, the lack of compensation shouldn’t be understood as meaning lack of regulation.

In many cases, peer-to-peer lending platforms, especially the ones which are members of the PPFA (Peer-to-peer Financial Association), offer their own individual schemes to provide compensation for investors.

 Since the Innovative Finance ISA was first launched, Zopa has attracted 12,000 new customers. - Personal Loans Now

How to Further Reduce Risk when Investing in an Innovative Finance ISA

Although it is true that there is no such thing as a risk-free investment, there are ways to reduce your exposure to risk.

One safeguard that P2P lending platforms have in place is their underwriting procedures to minimise risk for lenders such as carrying out credit checks. Therefore, higher interest rates tend to hint at higher risks. It could be that the borrower has a weaker credit score, a lack of business experience (for example, a start-up) or that loans aren’t backed by assets. Before investing, you should evaluate your own personal attitude to risk and what kinds of investments you’re interested in.

Another safeguard is that these platforms give you the freedom and flexibility to choose how to invest. They don’t usually let one person shoulder all the risks by being the sole investor. Instead, the money is lent by different investors so everyone’s portfolio is diversified. In this way, if one borrower defaults, lenders won’t lose all of their money.

Conclusion – Who Do Innovative Finance ISAs Suit?

Innovative finance would seem to have a promising future. Since it launched its first Innovative Finance ISA, the lending platform Zopa has attracted 12,000 new customers. Half of its new customer deposits up to March 2018 came via IFISAs. P2P lending, in general, can soar to reach £50 billion in the very near future. However, it might not necessarily be right for everyone.

An Innovative Finance ISA suits an investor who is interested in a financial product which is located somewhere in the middle between the safe Cash ISA offering low returns and the possible volatility of stocks & shares ISAs. As a beginner, it might be a good idea to test the waters by investing a token amount. Combining this with other ISAs you will be able to see if it’s the right option for you.

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