Should you invest in P2P lending through your ISA?
Cash and stocks and shares aren’t the only choices when it comes to using your ISA allowance.
You can also back British business and individuals through peer-to-peer lending using an Innovative Finance ISA (IFISA).
An IFISA lets investors earn interest from peer-to-peer loans tax-free.
You can use part of your £20,000 ISA allowance but can only choose an IFISA from one provider.
P2P lending has grown from a niche to a regulated sector that has funded more than £25bn of loans in the UK, according to AltFi’s 2020 marketplace lending report.
Well-known brands such as Zopa, Funding Circle and RateSetter have built billion-pound loanbooks but are absent from ISA season this year.
Consumer P2P lender Zopa has temporarily paused access to new investors to prioritise existing customers while liquidity is higher than usual.
Business P2P lender Funding Circle is currently focusing on lending under the government’s Coronavirus Business Interruption Loan Scheme, while RateSetter has exited the market following its acquisition by Metro Bank.
But there are plenty of other P2P lenders offering IFISAs with returns ranging from three per cent to double digits depending how much risk you are prepared to take, according to data from peer-to-peer analyst 4th Way.
This looks attractive in a world of record-low interest rates.
The rewards
Supporters describe P2P lending as an inflation-beating middle ground between the paltry cash ISA rates on offer and the volatility of the stock market.
“An IFISA offers all the benefits that come with any ISA wrapper, the only difference with an IFISA is that your money is invested in peer-to-peer loans,” says Martin Heelam, director of investor relationships at peer-to-peer lender Assetz Capital.
“Typically, IFISAs offer significantly higher target rates than cash ISAs, and less volatility than stocks and shares ISAs – although, as with any investment, your capital is at risk.”
Assetz Capital, which is currently the largest active P2P lender with a loanbook of more than £1bn, lets investors back loans to British businesses secured on property assets.
It offers target returns of up to 4.1 per cent depending on the account, but the rate may differ if a borrower fails to repay their loan.
Heelam says the property security gives investors an extra layer of protection as it can be sold to repay the loan if the borrower defaults.
Investors can also back property P2P loans on platforms such as CapitalRise or Proplend or unsecured consumer loans with Lending Works or Fund Ourselves.
Bruce Davis, managing director of Abundance Investment, which lets investors back green projects such as wind and solar farms, says the IFISA is a more productive way for people to use their money to support businesses and jobs.
He says IFISAs are popular with younger investors who don’t always feel that traditional finance institutions reflect their values and attitudes to money.
“They want to see their money ‘put to work’ and see the types of investment offered within the range of IFISAs to fit their needs and values more closely,” he adds.
Risky business
P2P lending may avoid stock market volatility, but it is not immune to economic issues.
Like any investment, there is a risk that you won’t get all or any of your money back if a borrower goes into arrears or defaults.
It can also be hard to get your invested money out when you want it.
Some platforms offer secondary markets to sell your loans, but there is no guarantee of a buyer. Many platforms such as RateSetter and Assetz Capital had to restrict or queue withdrawals at the height of the pandemic last year to cope with investors looking to access their money.
Platforms have also arranged repayment plans for hard-hit borrowers during the pandemic, meaning investors could wait longer to be repaid and may get less back.
Holly Mackay, founder of product analysts Boring Money, says these factors, as well as a lack of Financial Services Compensation Scheme protection, make IFISAs too risky for her.
“The concept is lovely – power to the people – but retail investors have to juggle default risk along with the risk that your provide could go bust,” she says.
Some argue that these may be risks worth taking.
“Investors are being paid to take a risk, the risk that the borrower is able to make their monthly interest payments and that the loan principal is redeemed at loan maturity,” says Brian Bartaby, chief executive of Proplend.
P2P analyst 4th Way advises investors to do their own due diligence, such as assessing management experience, credit criteria and loan performance history to get an idea of how risky each investment is.
“There have been few true disasters in P2P lending and the vast majority of diversified investors have made stable profits,” says Neil Faulkner, founder of 4th Way. “But, where the disasters have occurred, it has always coincided with a lack of information.”