The Innovative Finance ISA (IFISA) was launched in 2016, allowing savers to earn returns by making loans through peer-to-peer lenders. Since then more than £588 million of savings has already been stashed into Innovative Finance ISAs, according to trade body the Peer-to-Peer Finance Association.
This type of ISA matches up people who have money they’re willing to lend with borrowers who perhaps need a loan to pay for a new car, holiday or home improvements, or to fledgling businesses needing cash to expand their operations or purchase equipment.
Other types of peer-to-peer investments allow investors to lend their cash to specific types of project that pay much higher rates. For example, some platforms lending to commercial and residential building projects and others into renewable energy projects claim they offer double digit returns in some cases.
However, while the returns offered can appear very attractive, these are not guaranteed and there are several big risks to consider.
First, there is a danger that the business, individual or project you lend to cannot meet their repayments. Many peer-to-peer lending sites have contingency funds, which are designed to protect investors if this happens, but it’s well worth checking exactly where you might stand if a borrower does default on their payments.
It’s worth noting too that the Financial Services Compensation Scheme (FSCS), which pays savers up to £85,000 if a savings provider goes bust, doesn’t protect peer-to-peer investors in the same way.
This means that investors could potentially lose everything – and some already have with several peer-to-peer firms going bust in the last year.t.
There is a simple rule in investing, that the higher the return offered, the higher the risk you’re taking with your money. Because peer to peer lending is expressed as a % return, many ordinary investors have plowed money into them thinking they are as safe as a savings account. The reality is that those that are paying high rates of interest, do so to encourage investors to invest, but there is a real risk that you could lose your money.
Doing your homework and finding out what individual firms offer if something does go wrong is crucial. Experts generally suggest only holding a small amount of your savings and investments in this type of ISA, because of the risks involved.