Investors looking for a halfway house between cash savings and the stock market might consider peer-to-peer loans. The launch of the Innovative Finance Isa means individuals can enjoy tax-free returns on these investments, but there are risks attached to the asset class. Here's what you need to know:
What is an Innovative Finance Isa?
Launched in 2016 and also referred to as an Ifisa, these accounts let you invest in peer-to-peer (P2P) loans and some crowdfunding loans. The Government launched the Ifisa as a way of recognising the growing popularity of these types of investments and allowing investors to access them and enjoy tax-free returns.
How much can I invest?
Your £20,000 annual Isa allowance applies to these accounts, the same as any other type of Isa. You could put the full £20,000 into an Ifisa or spread it across different types of Isa if you prefer.
What is a peer-to-peer loan?
These are where you lend you money to an individual or business through a middleman – also called a platform – which is the peer-to-peer website. Individuals and businesses often opt to go through a P2P site rather than a traditional lender such as a bank because they might not be able to get a loan or the interest rates may be lower. Borrowers use the money the same way they would any other loan, to buy a car or fund home renovations, perhaps, or to invest in growing their business.
What are the benefits?
One of the main attractions for investors is that you can get a better interest rate through P2P than you would through a Cash Isa – typically between 4% and 6%.
Many providers will automatically split your money up into chunks so it is spread across lots of different loans, so you don’t lose all your money if one borrower doesn’t repay their loan. For example, if you invested £1,000, it might be split into £10 chunks across 100 different loans, providing instant diversification.
Neil Faulkner, founder of P2P comparison site 4th Way, says that for true diversification, investors should look to spread their money not just across hundreds of loans but across different P2P providers, although it’s worth pointing out that you can only put money into one Ifisa each year, so some of your investments may have to be outside of an Isa wrapper to achieve this.
Most P2P providers also have a reserve fund to cover any losses, so even if one of the borrowers you have loaned money to does default, you still get your original capital back.
What are the risks?
P2P lending should not be thought of as a straight swap from a cash savings account – your capital is at risk and even if a provider has a reserve fund, it might not cover your losses.
It can also be difficult to calculate exactly how much interest you can expect to get. When there is more investor money to lend out than there is demand for loans from borrowers, it can take a while before your money actually gets invested. Until your money has been loaned out, you will not earn interest. Crucially, once your money is lent out it does not have FSCS protection, so if the provider goes bust you lose your money.
It’s worth noting, also, that while peer-to-peer loans may be considered a potentially less risky investment than the stock market, they are also less liquid: you can buy and sell company shares at a moment’s notice, but if you want your money back from a P2P investment it could take time or come with a penalty.
What are some of the interest rates on offer?
Zopa was something of a trailblazer in this space, and has facilitated around £5 billion in personal loans since 2005 according to peer-to-peer comparison website 4th Way. Its popularity means interest rates are slightly lower than some competitors at around 3.4% although it does also offer a higher risk option, which lends to less creditworthy individuals and pays more. Another first-mover is Funding Circle, which focuses on business loans rather than those to individuals and pays around 4.5%.
RateSetter is another of the most well-known providers on the market, have lent out £3.8 billion since 2010. It issues loans to individuals and businesses as well as for property developments - you can expect interest of around 4%.
For something a bit more specific, Downing makes property and renewable energy loans to businesses and offers interest of around 5%, while Assetz Capital offers short-term bridging loans for property development and pays around 6.5%.
Faulkner likes CrowdProperty, which lends money to be used for property development and pays interest of around 7%. “When a project is funded, CrowdProperty hands it to the developers in tranches, which means you don’t have to worry that funds are going to suddenly dry up part way through a project,” he explains.
Rather than spreading your money out automatically, investors can choose which projects they want to invest in for themselves. While this means a bit more effort is required, it allows you the opportunity to find out more about the projects and what steps developers are taking to ensure they supply chain and labourers are safe, which is particularly relevant right now.
What are the key things I should check before investing?
- Make sure the provider is authorised by the Financial Conduct Authority.
- Ensure you understand what type of borrower your money is going to and are comfortable with that.
- Make sure you don’t need the money soon – this is an investment, remember, not a cash account so you should treat it the same as any other investment; that means having a long enough time horizon to ride out any ups and downs.
- Don’t be sucked in by a high rate of interest – remember, the greater the reward on offer, the greater the risk you are likely taking.
- Do your homework – just as with any other investment, this is crucial. Rresearch the provider, check their default rate (the proportion of loans that go bad or are paid late), how many customers they have and how long they have been around.
