Innovative Finance ISA (IF ISA) Risks: What You Need to Know
Innovative Finance ISAs (IFISAs) are growing in popularity as an alternative to cash ISAs and stocks and shares ISAs because they typically offer much higher interest rates than a cash ISA, and potentially lower volatility than a stocks and shares ISA.
Since IF ISA can be based on different types of peer to peer loans, you have more choice in terms of what you’re investing in. The most common and popular IF ISAs tend to be based on peer to peer personal loans, property loans and business loans.
An IFISA is an excellent alternative for people fed up with the paltry returns of a cash ISA and the unpredictability of a stocks and shares ISA, but as with any investment, there is risk involved. Before making an investment decision, it’s important to be aware not only of the potential risks, but also the measures that your provider has in place to secure your capital.
The nature of peer to peer lending is such that, as much as a lender might have measures in place to ensure a borrower doesn’t default, defaults can and do happen. As a result, you should look into the other security measures they have in place.
The main risks involved with IF ISAs
The main risk associated with IF ISAs is that they aren’t covered by the Financial Services Compensation Scheme (FSCS). The FSCS is the UK’s compensation fund and it protects customers when authorised financial services firms fail. It will cover investments of up to £85,000 in a cash ISA in the case that the bank fails or up to £50,000 for a stocks and shares ISA in the case that the provider fails. However, the FSCS doesn’t cover peer to peer lending, so it doesn’t cover IF ISAs.
In addition, loans may be unsecured, particularly those made to small businesses and personal loans made to consumers, which leaves your capital is at risk. As mentioned, borrower defaults can happen and the platform you’re using might fail.
However, if you do your research and ask your provider the right questions, you should be assured that there are measures in place to help reduce these risks, even if it is not possible to eliminate them altogether.
What can be done to secure an IFISA?
The different options for securing an IF ISA depend on the type that you’re investing in and the provider that you’ve gone with. Not all providers will offer the same level of security, so you need to ask the right questions to check their credentials.
You want your IFISA provider to have strict due diligence processes in place, and to conduct thorough research into borrowers in order to make sure that only reliable and credit worthy people and businesses are lent money. This will significantly decrease the likelihood of a default.
Another way to secure IFISA investments is to have a legal charge over the asset for which the loan is required. This might be, for example, a property. If a legal charge is in place, your provider can force the sale of the asset if the borrower defaults so that investors can be paid back.
Some platforms also have a reserve fund of capital to meet or partially offset any major shortfall, but these aren’t always guaranteed. In addition, conservative loan-to-values (LTV) can be set to provide more protection in the event the asset market dips (e.g. on property loans, to protect against property market fluctuations).
For example, if someone borrows £150,000 to purchase a house worth £170,000, the LTV ratio is £150,000 to £170,000 or £150,000/£170,000, or 88%. The remaining 12% represent the lender’s ‘haircut’, adding up to 100% and being covered from the borrower’s equity. In short, the higher the LTV ratio then the riskier the loan is for a lender – so conservative LTVs offer better security.
The House Crowd’s IFISA – a secure, reliable and fruitful investment
At the House Crowd, we take security seriously. All our investments have a legal charge against borrowers’ property, conservative LTVs are set on all loans to protect against property market fluctuations, and we conduct thorough credit checking and due diligence to assess potential borrowers.
The House Crowd’s Innovative Finance ISA (also known as a peer to peer lending ISA) offers a target rate of 7% per annum. It automatically diversifies your investment across a portfolio of secured peer to peer lending and property development opportunities. Investment starts from £1,000 and you can either compound your interest or receive it twice a year.
Capital at risk and rates not guaranteed. Withdrawals may be restricted due to illiquidity. Not covered by the Financial Services Compensation Scheme (FSCS). Please read our full Risk Warning.