Ever since the introduction of Innovative Finance ISA in April 2016, the number and variety of services available have increased. It can be difficult as an investor to choose between these services. Majority of Innovative Finance ISAs fall into one of three categories: individual loans, property loans and small business loans. Consumer loans Innovative Finance ISA usually offers returns of around 4% or 5% per year on unsecured loans. Some peer to peer lending platforms allow investors to start with a small investment of as low as £10. Business loan IFISA usually offer returns between 6 to 7% range, with a minimum amount of investment starting at only £100.
IFISA that are backed by property democratise investing in estate and are right for people who wish to avoid the hassle and related costs of investing in bricks and mortar. Typically the minimum investment begins at £1,000. The interest rates can be high than other types of loans which often range between 8% and 10% per year on self-selected investment projects and 5 to 8% on a diverse portfolio.
How willing are you to take risk?
As an investor, you need to understand that the rates that companies quote are not guaranteed. These are investment Individual Savings Accounts (ISAs) and are not protected by the Financial Services Compensation Scheme (FSCS) that pays investors up to £85,000 in case of bad debt.
Innovative Finance ISAs which incorporate peer to peer loans that are backed by property, offer high returns with the protection based on the property value. Still, there are some risks involved. Properties can go wrong with a mistake by a value, through fraud or an error could be made while securing the assets. Therefore, it is critical to pick a level of risk that you feel comfortable with. Typically, if the target rate is high, there is a bigger risk than loans might run into trouble with defaults or lay repayments.
Are your investments diversified?
If you want to mitigate risk, then diversification is an essential factor. Majority of peer to peer investing platforms offer two means of investing, including ‘self-invest’ and ‘auto investments UK’. All the investments are offered in a tax-free wrapper. Diversifying your investments among different types of projects allow you to mitigate any potential loss.
Self-select projects may provide high target rates. However, the chances are that there will be some downtime between your investments, and you might not earn any interest, and it can decrease the overall return.
On the other hand, with auto investments, you can make your money work for you 365 days a year. In addition, you can earn regular interest that can be rolled up, so your overall returns can be better with an auto-investment option compared to select-invest, even if we don’t take the tax-free wrapper into consideration.
Does the ISA allow you to compound your returns?
In investment compounding is important for growing long-term returns and with auto-invest that can be done the best as the interest is paid twice a year. If it’s rolled up in a tax-free wrapper, then it can tremendously maximise the size of your investments over a period of 25 years. However, you need to be able to handle some risk if you wish to capital growth.
IFISA offers better returns without the instability of the stock market, but the target interest rates are not guaranteed. You have to make sure that you diversify your funds across a variety of different peer to peer loans. To manage the risk, you also have to either ensure that you have the security of a property-backed loan or you should check if there is a provision fund to cover in case of default loans.
IFISA is an excellent investment opportunity, regardless of your investment experience. If you are ready to take some risk, are happy to tie up your funds for long-term and want to grow your savings over time, then you should look into Innovative Finance ISA. Just make sure that you understand how everything works before you commit to the investment. There are a lot of experienced IFISA providers available in the market. Do your research and read about the platforms so you can choose the one that is right for your financial strategy.
