Innovative finance Isas: high rates mean higher risks
With an innovative finance Isa, peer-to-peer lending can offer tantalising interest rates – but be sure to be aware of the potential pitfalls
In the wake of the financial crisis in 2008, credit was hard to get for many businesses as banks rebuilt their devastated balance sheets. Meanwhile, as interest rates hit rock bottom, investors found that getting a decent return from traditional savings products proved difficult. As a result, a whole new financial sector sprang up, known as peer-to-peer lending (P2P). Investors could put their money into platforms such as Zopa and RateSetter, which would lend it out to businesses and individuals looking for finance. Savers got a better interest rate and borrowers got access to credit at cheaper rates than banks offered.
As the sector matured, the government introduced Innovative Finance Isas (IF Isas) in 2016, which allowed investors to obtain tax-free returns from their P2P loans. But they took a long time to gain traction. The approval process was lengthy – providers had to obtain authorisation from both HMRC and the regulator, the Financial Conduct Authority (FCA) – so many providers decided not to bother. And many investors weren’t even aware of their existence.
A specialist product
Today, they remain a niche product. In December 2019, the FCA introduced rules that prevented new investors from putting more than 10% of their assets into the sector without independent advice, and, generally speaking, IF Isas are now only available to “sophisticated” investors, high net-worth investors, or institutional investors.
Take-up, partly as a result, has been low. In 2019-2020, the latest period for which figures are available, the number of adult Isas of all types subscribed to was 13 million, up from 11.2 million in 2018-2019, with £74.6bn invested, up from £67.5bn in 2018-2019. However, of those, just 34,000 were IF Isas. That number is falling – down from 38,000 the previous year and 49,000 the year before. The amount of money invested has risen, but only from £328,000 to £438,000. Compare that with Junior Isas, with 1,023,000 accounts subscribed to, up from 954,000 in 2018-2019, with £971m invested.
Not only are fewer people putting their money into IF Isas, but the number on offer has dwindled too. Three years ago you could choose from perhaps 40 IF Isas; today there are only around 30. The sector has had something of a rollercoaster ride, with many providers coming and going. Zopa, the first and at one point biggest lender, has gone mainstream – in 2020 it received a banking licence from the FCA, and in December 2021, it closed its P2P business. It never offered an IF Isa. RateSetter, the second-largest platform, was acquired by Metro Bank, and has stopped taking investors’ money altogether.
Many other providers have gone by the wayside. Perhaps the most high profile was Lendy, a property crowdfunding platform that went bust in 2019. FundingSecure entered administration the same year, and The House Crowd did the same in February 2021.
Still, in a world where interest rates remain low, and even the best cash Isas are nowhere close to matching inflation, headline interest rates on IF Isas can look very tempting indeed. Ablrate and Crowd2Fund both offer 15% from lending to small businesses. And both Landlordinvest and Proplend offer up to 12% on property loans.
Ethics and innovation
If you’re particularly concerned about impact investing or the “ethical” aspects of where you put your money, there are a few options – indeed, this is an area that seems to be expanding. Ethex offers a return of up to 10% on community energy and other social-enterprise projects. Abundance offers 8% from renewable energy. Energise Africa offers up to 7% investing in renewable energy projects in Africa. And Triodos Bank is offering up to 7% from investing in small community projects, including renewable energy, community businesses and charities.
But if you do decide to put some of your money into an IF Isa, make sure you can afford to lose it. The projects themselves carry risk, of course, which is one reason the returns are so high. Some lenders operate their own contingency funds that aim to pay out if borrowers start defaulting on their loans, but they can only deal with a low level of default. And not all platforms offer this service, so it’s probably best not to rely on them bailing you out should things go badly. And while the platforms are technically mere conduits for your money, if one does collapse, it could take a long time to get your money back.
You may also have to tie your money up for a lengthy period of time. Some (not all) platforms offer a secondary market where you can sell unmatured investments, but even those that do offer this option do not guarantee that you will be able to sell, or even that they will continue to offer the service. In other words, assume that you will be unable to get your money out until your investment matures – so make sure any money you invest won’t be needed in a hurry.
Another problem with IF Isas is diversification. Because each platform tends to specialise in a particular niche – small businesses, consumers or property developers, for example – and you can only contribute to a single IF Isa in any one tax year, it is almost impossible to spread your investment easily across all the sectors available. That could expose you to a much higher risk than you are comfortable with.
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