Why investing in Innovative Finance ISAs could be hugely rewarding

The Innovative Finance ISA, or IFISA, is the least well-known and arguably least successful Isa product on the market.

Latest government statistics show that there were only 34,000 such products opened in the 2019-20 financial year, a drop on both of the previous two years since their launch.

Customer caution is perhaps unsurprising, given that even the government’s own financial regulator says that IFISAs are ‘high-risk’, and has put measures in place to stop many ordinary investors putting too much of their Isa allowances into them.

However, with inflation at 6.2%, and many of us searching for ways to get a higher return on our money, it can’t be denied that those Ifisas still available offer a higher rate than ordinary savings accounts, which can be attractive to some.

Here’s how they work…

What is an IFISA?

An Innovative Finance Isa allows you to put money into what are called peer-to-peer loans. These are loans made directly – frequently to small businesses, other individuals, charities or property developers, who might struggle to get cheap lending from banks.

Typically the rates are much higher than on cash savings, but because you are lending to individuals or businesses, there is no guarantee they won’t default because of business troubles. The Isa wrapper allows any returns to grow free of tax, just as with any other type of Isa.

What is peer-to-peer lending?

Peer-to-peer lending, sometimes called crowdfunding, became popular several years ago, with companies such as Zopa, RateSetter and Funding Circle all offering individuals the chance to lend directly to investors.

Many offered ‘guarantees’ to ensure that investors were still repaid to some extent in the event of default, and in some cases borrowers were vetted to attempt to ensure they were safe bets.

Many of these lenders have now exited the peer-to-peer market. Funding Circle, which lent individual money to small businesses exited this month, while Zopa shut down its peer-to-peer arm to become a digital bank, and RateSetter was bought by Metro Bank and stopped focussing on lending.

What’s available now?

There are still some IFISAs available, and you can choose to open a new one or transfer money from an existing stocks and shares or cash Isa.

These include an IFIS from ethical bank Triodos, which offers investments in charity or community projects.

It is just about to open a new inflation-linked bond for investment in its IFISA, paying 4.25% rising with inflation, investing in solar panels in Salisbury
and Arbroath.

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