What Is an Innovative Finance ISA?

In times of low interest rates and rising inflation, investors look to non-traditional sources to find investments that will yield large returns. With bank interest rates on cash savings accounts maxing out at around 1.3% these days, it’s no surprise that a few alternative options have started to become fairly popular in the current economic climate.

Innovative finance ISAs, a type of individual savings account, are rising in popularity, particularly as many are seeing returns of up to 7%. Whether 2020 is the year you want to start saving or you’re busy updating your long-term savings plans, considering an IF-ISA as a new investment may be a good place to start.

What Is an Innovative Finance ISA?

Innovative finance ISAs, or IF-ISAs, refer to a specific type of individual savings account that gives consumers the chance to earn tax-free interest through a peer-to-peer lending network. These ISAs pair up willing savers (investors) with individual and business looking to become borrowers

There are many IF-ISA providers in the market, each providing lenders with the chance to pinpoint exactly which industries they would like to invest in. IF-ISAs cut out the middle man (the bank) completely, reducing overheads and leaving leaving room for higher rates of return.

The Pros, the Cons and the Risks

As with all ISAs, there are pros, cons and risk factors to consider when it comes to IF-ISAs. Detailing a few allows us to get a holistic sense of IF-ISAs in general.

The pros of innovative finance ISAs

• On average, IF-ISAs earn higher rates of return (often more than double) than traditional savings accounts.
• The IF-ISA market is relatively new so it has low entry barriers. This ensures a multitude of investment options, as well as various competitive rates from possible providers.
• For basic taxpayers, the first £1,000 of interest earned through an IF-ISA is tax exempt. Higher rate taxpayers are offered £500 tax-free interest earnings. This amount can be reinvested right away, which will compound your earnings.
• If you are a company and you are making regular payments into an ISA, this may reflect well when it comes time for financial expansion in the form of secured-business, or revenue based loans, especially if your company is utilising open banking software to track your payments.

The cons of innovative finance ISAs

• Consumers are only allowed to open one new IF-ISA with a single provider per tax year. There is also a yearly cap of £20,000, which must be spread between all ISA types owned.
• IF-ISAs invest in different loan categories, so it can be hard to predict how loans will perform. This is mostly because there is little historical data to use as a reference.
• Other types of ISAs offer fixed returns (cash ISAs) and FSCS protection (as with stocks and shares ISAs), but IF-ISAs offer neither. Returns can vary and if the provider goes under, your money goes down with it.

Keeping these pros and cons in mind, IF-ISAs are generally considered to be medium to high risk investments. A convenient way to mitigate this is to secure an investment against a fixed asset, like a house or a commercial building, and to start investing with a small amount, growing your portfolio over time, rather than investing everything in one go.

How Can You Invest in an Innovative Finance ISA?

Opening an IF-ISA account is a relatively straightforward process that should only take a few minutes to complete. Once your IF-ISA provider has been chosen, the first step is to complete a registration form on their website. You will have to provide your name, email address and a secure password. 

With some providers, there may be an option to register as an individual or as a company. If this is the case, ensure that names given match up with existing ID documentation (for individuals) or with the registered business name (for companies). Applicants will need a valid UK bank account to qualify, as well as a valid photo ID. Some providers may perform a credit check, though this is not always a requirement. 

After registration is complete, you will gain access to an online portal that will allow you to transfer of funds from the bank to the IF-ISA provider – and just like that, your money is invested. Voila!

A View Towards Saving For the Future

It’s never been easier to kickstart a savings plan, and by beginning with an IF-ISA, it’s possible to start investing tax-free as early as today. Over 10 million households in the UK having no savings so there has never been a better time to start prioritising your savings account, particularly in the wake of relative uncertainty around Brexit and economic performance.

You only need a small portion of funds to get started, then you can begin monitoring your progress carefully, investing more as your confidence grows and ultimately developing a well-oiled personal savings strategy.