5 Questions to Ask Before Investing in an IFISA
ISA season is approaching, and more and more savers are starting to consider the Innovative Finance ISA (IFISA) as an alternative to the low returns of Cash ISAs and the unpredictability of Stocks and Shares ISAs.
In fact, between the 2016/17 tax year and 2017/18, subscriptions into IFISAs rose by more than 700 per cent , as their benefits gained wider mainstream appeal.
There are now more than two dozen IFISA providers in the UK, offering tax-free returns on secured loans, where interest can be collected (or reinvested) on a monthly basis. As with any ISA wrapper, up to £20,000 can be put away each tax year, and on 5 April 2019, the annual allowance resets. This means that between now and early April, an increasing number of IFISA accounts are likely to be opened.
But if you are one of the many people considering a first-time IFISA investment, there are a few questions that you should ask yourself before making any big decisions…
1. Do I already have an IFISA?
As with other ISA wrappers, individuals can only open one IFISA per tax year. If you already have an IFISA account which you opened this tax year – even if it’s only worth £10 – you will not be able to open a second one.
Having said that, it is possible to transfer your existing IFISA balance into a new IFISA. All IFISA providers offer this service, and it is in their best interests to make the process as easy as possible for you.
If you wish to transfer your IFISA from one account to another, make sure you check the fine print as it may take up to 30 days for the transfer to complete. This means that you may need to begin the transfer process before the end of February, in order to make sure that you can maximise its use in the 2018/19 tax year.
You can also transfer some or all of your ISA balance from a Cash ISA or a Stocks and Shares ISA.
2. Is it flexible?
Flexible IFISAs are becoming more common, and they are a nervous investor’s dream come true. A flexible IFISA allows you to make withdrawals and re-investments throughout the tax year, without affecting your annual allowance.
This is significant as many ISA providers still discourage withdrawals by effectively reducing your allowance: so, if you had £10,000 in your ISA and you withdrew £5,000, you would only be able to add a maximum of £10,000 to that ISA account during the rest of the year.
If you had a flexible ISA, you could withdraw that £5,000 and still have £15,000 left in your annual allowance.
3. Do I understand the risk?
The risks associated with IFISAs are very different from the risks found in Cash or Stocks and Shares ISAs.
IFISA investors are investing in loans, and so the main risk is that the borrower will default on their repayments. This can present a substantial risk, as the worst-case scenario is that the lender (i.e. the IFISA investor) will lose their entire capital investment.
However, in reality this is unlikely to happen as long as you understand how the provider operates.
Most platforms automatically diversify their lenders’ money across a range of loans, and many IFISA providers use provision funds, ‘skin in the game’, or insurance policies to reduce the risks to investors.
As a general guide, the average default rate for all Peer2Peer Finance Association IFISA providers is around two per cent .
4. What is the platform’s default plan?
Loan defaults are inevitable, no matter how secure an IFISA provider’s credit check system may be. However, shrewd platforms will be able to rely on their in-house default plan to reduce the impact of any defaults, or to eradicate them altogether.
In some cases, a provision fund will exist to help cover the costs of any defaults. Alternatively, the platform may operate a ‘tranche’ investment scheme, where the first 5-20 per cent of each loan is covered by a lending partner or by the platform itself. This acts as a shield to protect retail investors from the first loss.
Every platform should also have a clear and tested recoveries plan which can kick in as soon as the first signs emerge of a potential default. For instance, if your IFISA is invested in asset-backed loans, the recoveries plan might involve taking possession of the asset and using that to repay your capital.
Find out what your IFISA provider’s default plan is, and do not invest any money until you are satisfied that they are taking a responsible approach to this risk.
5. Is there a secondary market?
When you are investing in loans, most of the time you have to accept that your money is locked in for the duration of the term time, which can vary from months to years. However, a secondary market can provide a ‘get out clause’, by offering you a place to sell off your loans or loan parts to other IFISA investors.
The liquidity of the secondary market will depend on the number of users on the platform, and the ease of trading loans. In most cases, secondary market trades can be completed with in 48 hours, although it is worth checking each platform’s record on this.
Updated: Monday, February 18th, 2019