The new Innovative Finance ISA – what is it and how does it work?

Following years of low interest savings rates for investors, many people are desperate to find new ways of giving their finances a boost. With traditional ISA accounts offering between 1.3% and 2.15%, the incentive to save has taken a hit over the past few years.

In a bid to reignite our motivation to save, the UK Government has launched a number of new ISA products, such as the Lifetime ISA, over the past twelve months. Adding to the list from April 2016 is the IFISA, or Innovative Finance ISA.

So how does it work?
The Innovative Finance ISA allows any UK taxpayer, over the age of 18, to use some or all of their annual ISA allowance to lend funds through the growing Peer-To-Peer (P2P) lending market whilst receiving tax-free interest and capital gains. Peer-to-peer lending, sometimes referred to as crowdfunding, has been shaking up the lending market for some time; covering personal loans, small business loans and property loans, it essentially cuts out the banks by putting people with money to lend in touch with those who need to borrow, allowing borrowers to pay less interest and lenders to receive better returns on their investment. The types of businesses that benefit from this kind of lending generally tend to be start-up companies or small-medium enterprises looking to grow their business.

The idea is that any initial money lent via P2P will eventually increase further down the line; as borrowing businesses repay their loans, those funds then become available for another business to borrow. For example, in December 2012, the UK Government injected £20m of state funds into the P2P lending space via Funding Circle by the Business Finance Partnership (the predecessor to the British Business Bank*). They have since publicly revealed that their initial £20m of loan capital resulted in a total of £130m being made available as loans to SME’s.

Sound almost too good to be true? The main catch of an Innovative ISA is that it comes with much higher risk than simply putting your money into a UK bank or building society account. Peer-to-peer lending isn’t covered by the official Financial Services Compensation Scheme (FSCS) meaning any capital invested is at risk. That said, many of the authorised providers are offering safeguards of their own.

Surprisingly, the P2P lenders that you may have heard of are yet to be fully authorised to provide the IFISA. In order to act as an ISA manager, companies require authorisation from the Financial Conduct Authority plus the approval of HM Revenue and Customs. Zopa, Ratesetter and Funding Circle are all still waiting for the green light to proceed, meaning current options are limited to lesser know providers.

Here are details of some of the current IFISA providers:
Lending Works – the first major P2P lending platform to receive FCA authorisation; current rates are 4% for three-year lending and 4.5% over five years

Landlord Invest – as it sounds; enables people to invest in residential buy-to-let mortgages and bridging loans with projected returns of up to 12% per annum

LendingCrowd – matches investors with SME’s seeking loans offering a target return rate of 6% per annum

As with any investment, you should carefully consider your financial situation and consult your financial advisor as to the suitability of your situation prior to making an investment or entering into a transaction. The value of your investments can go down as well as up, so you could get back less than you originally invested. However, if you have some money that you are willing to invest speculatively over the short to medium term, P2P lending could be an option, depending upon your circumstances.

To recap:
• You can split your £20,000 annual ISA allowance across multiple forms of investing, including the IFISA
• You do not have to invest in a single lump; you can spread your investment throughout the year
• You can transfer funds from existing ISAs accumulated from previous years into an Innovative Finance ISA
• You are only permitted to hold one Innovative Finance ISA per tax year

*The Business Bank PLC is a Government established UK state -owned bank that was launched in November 2014 by the Conservative government. It was formed with the sole intention of increasing the availability of credit to the UK’s SME’s.

Capital at risk, investments can fall as well as rise. Peer to Peer Lending and an Innovative Finance ISA could be high risk and might not be suitable for every type of investor. You should seek professional financial advice if you are considering one.

Sources:
https://innovativefinanceisa.org.uk/the-isa/
https://www.theguardian.com/money/2017/feb/18/innovative-finance-isa-tax-free-high-returns-risky