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With the introduction of many new products with interest rates that outweigh cash Isa and savings rates, the field of the innovative finance ISA (IFISA) continues to expand. While the new breed of innovative ISAs offers attractive rates of returns, they are not without risks. If anything, they bring with them additional risk.
To determine whether the new wave of high interest fixed rate IFISAs is right for them, savers need to understand both the advantages and risks associated with these ISAs. Put simply, there is a good side and a bad side to IFISAs, and it is important to find out if the good side outweighs the bad side or it’s the other way around.
Announced by the Government in April 2016, the innovative finance ISAs or IFISAs give ordinary savers the chance to invest in growing UK businesses. This opportunity is provided via the growing peer-to-peer (P2P) lending market, also known as crowdlending. These platforms cut out the banking middleman to offer both the savers/investors and the borrowing businesses a better rate.
With the launch of IFISAs, savers can now make investments into the sector and get returns without having to worry about capital gains or income tax deductions. Some of the first IFISAS to be launched included the likes of London Capital, Finance ISA, and easyMoney ISA.
Launched by finance brand easyMoney, easyMoney ISA distributes invested money into several P2P loans that are backed by property. A first legal charge over a property secures all loans. easyMoney ISA has a targeted return of 7.28%, which is one of the higher rates out there.
However, it’s not all milk and honey as seen in the case of London Capital Finance. With over 12000 investments made, London Capital and Finance started as a leading provider of fixed-rate bonds and ISAs. London Capital offered fixed annual interest rates of 6.5%, 8%, and 8.95%, over 2, 3, and 5 years respectively. As evident here, IFISAS can give very good rates tax-free, but savers need to be aware that it is an investment and not a savings account. This is the mistake that London Capital ISA investors made.
Savers face losses worth £236m after the collapse of the London Capital. The IFISA is currently being investigated for mis-selling. Peter Thornely—a former teacher—says that he has lost 35 years’ worth of savings due to the scandal. At this point, you may want to ponder if investing in IFISAs is worth the risk. To do that, you need to know the risks associated with IFISAs. Before we get to them, let’s quickly look at a few critical things you need to know about innovative finance ISA.
Although the right IFISA for you will depend on your circumstances, there are a few important things to consider before choosing one. These include the following:
In each tax year, you are only allowed to have only one IFISA. However, you can make investments in stocks, cash ISA and shares within the same tax year provided your total investments don’t exceed the allowance by ISA. The ISA allowance for 2020/2021 is £20,000.
It is important to know the risks associated with IFISAs to avoid the same fate as those who invested in London Capital. While P2P platforms try their best to minimize risk by carrying on credit checks on prospective borrowers, there is always the risk that the businesses seeking investments from savers will go bust or default. Additionally, like most P2P lending activities, the IFISA is not covered by the Financial Services Compensation Scheme (FSCS), which puts the lender’s capital at risk.
Another risk for savers is the difficulty in accessing their capital. While some providers of IFISAs allow lenders to ‘sell’ their loans, such mechanisms generally require that a willing buyer is found for every part of the loan.
Since there is no guarantee against investors’ capital, it would be beneficial for savers to review and understand risk within P2P lending, particularly the new wave of high-interest IFISAs. It would also be useful to diversify your portfolio to get the best returns and minimize risk.