When people talk to me about Isas, they tend to mean cash or stocks and shares versions – or occasionally Junior or Lifetime Isas. But there is a fifth, unloved, type of Isa that almost everyone has ditched or forgotten about – the Innovative Finance (IF) Isa.
I think that’s a shame. IF Isas may have flaws but I’ve been earning double-digit tax-free returns in mine. They allow you to lend to individuals, companies or developers – bypassing the traditional banks to offer loans directly.
As with all types of Isa, any returns are tax free. You can invest up to your full allowance of £20,000 in a tax year. The loans are typically made by several individuals clubbing together, so are sometimes known as crowdfunding or peer-to-peer (P2P). They tend to be riskier than other types of Isa because if a borrower defaults, you may not get your money back. That means you must be careful about which projects you choose to fund and do your homework first.
It also means that for most people, an IF Isa should only be used for part of your tax-free saving. However, the upside of taking on more risk is that you tend to be rewarded for it. I am among just 17,000 people who have taken out an IF Isa – compared to 3.9 million with stocks and shares and 7.1 million with cash versions.
I prefer IF Isa and P2P products backed by physical assets such as property development, infrastructure or land purchases, because if the lender defaults there is an asset that can be sold to recoup the debt.
Innovative Finance Isas allow you to lend to individuals, companies or developers – bypassing the traditional banks to offer loans directly
One IF Isa I hold is with Shojin, a P2P company that lends to developers that are building or renovating mid-market residential blocks, generally valued at £10 million to £100 million. They tend to be in major cities or commuter belts and the returns are usually between 14 and 20 per cent.
Money is lent to individual developers for specific projects rather than being spread across various ventures. So if one project fails you could lose your money, whereas if it were spread across various projects you would be less exposed.
However, if the risk were spread the returns would also be lower.
I have money in three projects – all of which are on track to make some decent cash – and, naturally, all of my investments combined only make up a small proportion of my overall portfolio.
I also invest in a non-Isa P2P product called Blend Network. Their loans currently give an average 10 per cent return. Because these are not within an Isa, there is tax to pay so the real return is closer to 8 per cent. Again, there is risk involved as they also lend to individual projects.
However, in five years I have had no losses. But I’m gradually moving money from that into Isa-wrapped investments. I’ll start with Folk2Folk, which has been operating since 2013 and does similar loans to Blend but within an Isa. Rates start from 8.75 per cent.
Folk2Folk started by enabling people within a 40-mile radius of Launceston in Cornwall to lend to others who were purchasing land, growing a business or developing buildings. Managing director Rory Warren says: ‘We typically offer a loan to value of up to 60 per cent which gives extra security and we only lend to UK businesses.’
He admits that they sometimes have loans where there are delayed interest payments or loans that have gone over maturity, which they actively manage. In those instances, borrowers pay a higher rate of interest to compensate investors. To date, they have had no capital losses.
Folk2Folk’s minimum investment is £20,000. ‘We do that to ensure a committed investor base of high net worth and sophisticated investors,’ says Warren.
Around 65 companies are authorised to offer IF Isas, but only 40 currently market them. Most of the products are either crowdfunding or P2P lending.
Personally, I’m more interested in asset-backed peer-to-peer lending. Crowdfunding can be lucrative but, in my view, it’s a lot riskier and demands more research on the part of the investor.