The growing popularity of alternative savings and investments schemes, such as peer-to-peer loans and crowdfunding services, has led to the government creating a new ISA category: the Innovative Finance ISA. Launched in April 2016, innovative finance ISAs are a half-way house between a cash ISA, which is safe but yields a low return, and a stocks and shares ISA, which offers more reward but carries far greater risk. Put simply, innovative finance ISAs enable you to lend out your own money – a bit like being your own bank manager.
So how exactly does it work? Peer-to-peer lending is essentially a scheme that matches borrowers with investors. Your investment is pooled with those of other investors and lent out to a number of borrowers. They pay the money back over a period of time with added interest, and you receive the interest they pay, minus any costs involved. The number and type of borrower you can lend money to will vary between peer-to-peer lenders, but they’re usually individuals looking to borrow cash for a new car or house extension. Some peer-to-peer lenders such as Funding Circle only offer finance to businesses, while others such as RateSetter offer both businesses and individuals access to investors’ money.
If all goes according to plan, the people or businesses you lend to will pay you your money back over time, with interest. Investors who are able to commit the full ISA amount for a five-year lock-in period could potentially earn up to £914 a year interest. However, while some investors see the scheme as a relatively safe way to invest money, many are fiercely critical of the ISA, such as Lord Turner, the former chief of the Financial Services Authority. Shortly before the introduction of innovative finance ISAs, Lord Turner appeared on BBC Radio 4 and predicted that there would be huge losses for peer-to-peer lenders over the next five to ten years – losses that would make banks look like “lending geniuses”. Ultimately, if your borrowers cannot keep up repayments, you will, in theory, lose your money. And unlike cash ISAs, your money will not be protected by the Financial Services Compensation Scheme (FSCS).