Businesses looking to raise capital at competitive rates and private investors who want a better return on their savings are starting to become interested in the possibilities offered by peer to peer lending and, more specifically, innovative finance ISAs.
Since its inception in 2005, peer to peer lending has grown from an alternative investment choice to a mainstream technique. With interest rates at record lows over the past decade and the stock market, foreign currencies and other investments exhibiting higher-than-normal volatility, peer to peer lending has been seen as one of the very few ways for investors to generate stable returns.
In this article, we’ll take a closer look at what peer to peer lending is, what innovative finance ISAs are and how the two are linked.
What is Peer to Peer Lending?
Peer to peer (P2P) lending allows businesses and individuals looking for credit to obtain loans directly from other individuals rather than having to go to the bank. By cutting out the middleman — i.e. financial institutions such as banks — the intention is that the borrower (the business or individual) and the lender (the private investor) receive better rates of interest than they would otherwise be able to access. That means cheaper loans for the borrower and better returns for the investor.
Peer to peer lending is usually facilitated through an online platform that connects borrowers directly to investors. Investors can sign up, deposit a sum of money they’re willing to lend and indicate what rate of interest they’re looking for. The borrower can then review the available offers and accept one or multiple offers with interest rates that they are willing to pay. The money transfer and monthly payments are then administered through the online platform.
Find out more about the pros of peer to peer lending.
What are IF-ISAs?
An innovative finance ISA, commonly known as an IF-ISA, is a financial product that falls under the broader umbrella of peer to peer lending. It is a relatively new form of individual savings account (ISA), that allows individuals to benefit from tax-free returns on the peer to peer loans they make.
In terms of risk and reward for the individual, an IF-ISA sits somewhere between a cash ISA (very safe but low returns) and a stocks and shares ISA (riskier but with the potential for higher returns). That makes it a very attractive option for many people who are looking for better returns than savings accounts with the banks and cash ISAs can generate.
There are already a broad range of prospective borrowers out there who are looking to raise money in this way. Consumers, businesses, infrastructure developments and other projects all want to borrow money from investors who will receive tax-free interest on the money they lend in return. And, as the sector continues to grow, the array of options available to investors will continue to grow.
The rates of return private investors can expect to earn typically range between 4-7%, with some IF-ISA providers allowing lenders to invest as little as £100. As is the case with any investment, the higher the rate of return, the greater the risk is likely to be.
How Do the Two Go Together?
Peer to peer loans and IF-ISAs are undeniably linked, which is why innovative finance ISAs are also commonly referred to as ‘peer to peer ISAs’, ‘peer to peer lending ISAs’ and ‘P2P ISAs’. Almost all of the IF-ISA providers in the UK are also peer to peer lending platforms, with the IF-ISA offered alongside ordinary P2P loans.
The benefit of having a P2P loan wrapped up in the IF-ISA packaging is that all the returns generated are tax-free. The downside of the IF-ISA product over ordinary peer to peer loans is that investments are capped at the annual ISA investment limit of £20,000. That means any investment over the value of £20,000 in a single year will have to go into an ordinary P2P loan and tax will be payable on the returns.
Although the peer to peer lending sector currently dominates innovative finance ISAs, there have been suggestions that equity-based crowdfunding, where individuals invest in a new company in return for a share of the business, may also be given innovative finance ISA status soon.
Is an Innovative Finance ISA Right for You?
As with most investments, it’s down to each investor to weigh up the risks and rewards offered by an IF-ISA before making any final decisions. It’s also important to note that innovative finance ISAs are not protected by the Financial Services Compensation Scheme (FSCS), which means your capital is at risk and your returns are not guaranteed. For that reason, it’s important investors look at the security offered by individual IF-ISA platforms before deciding whether it’s the right investment for them.
