Peer-to-Peer Lending ISAs

The available peer-to-peer lending ISAs (P2P ISAs) can be viewed in the table below. The definitions of various terms used on this page can be found in our glossary, and further information for each ISA provider is given on the links below.

Please note: Many IFISA accounts offer high returns. However, peer to peer lending and IFISAs are not protected by the FSCS. It is important to fully understand the risks before opening an account. Capital at risk.

Further information surrounding the new peer-to-peer lending ISA can be found in topic navigation below, as well as through various other links on this website.

Peer-to-Peer Lending ISA

The peer-to-peer lending ISA, officially named the ‘Innovative Finance ISA‘, was announced by George Osborne in the 2015 summer budget, and launched on 6 April 2016 to coincide with the beginning of the 2016/17 Tax Year. These investment wrappers were introduced by Government as a means to allow investors to shield the returns from peer-to-peer lending activities from both Income Tax and Capital Gains Tax (CGT).

Peer-to-peer as we know it today was first pioneered in 2005, providing an innovative means for individuals and businesses seeking to borrow money to partner directly with lenders, in effect cutting out the banking middle man and enabling both parties to benefit from a narrower spread between the rate paid by borrowers and the rate received by lenders. The popularity of peer-to-peer lending has gone from strength to strength in recent years, owing principally to the investment returns on offer in the peer-to-peer lending space, and also owing partly to the relatively lacklustre returns that have been offered by those serving traditional Cash ISA market. Now, following the Government’s incentivisation – which has included the direct injection of some £40,000,000+ into the peer-to-peer space, followed by the introduction of the new ISA, the peer-to-peer/ISA amalgamation has brought this form of investing well and truly into the mainstream.

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Comparing Peer-to-Peer Lending ISAs

There are investors who are used to shopping around for the highest return on funds through simple metrics, such as the interest rates offered by banks or building society savings accounts and Cash ISAs for example. In an environment in which cash investing products can often be relatively homogenous. investors may very well not understand the specific nuances applicable to the wide range of options available within the peer-to-peer lending ISA space. It is therefore vital that investors understand that individual ISA providers can be difficult to compare directly and unambiguously. The plethora of peer-to-peer lending ISAs which have been launched in recent months (and which continue to be introduced to the market) can serve widely and fundamentally different borrower markets – using a range of lending products.

Prospective backers should to commit time to understanding the nature and structure of their specific ISA’s investments, including the nature and makeup of the borrowers served by that ISA, as it is virtually impossible to compare individual peer-to-peer lending ISAs on a purely like-for-like basis. Some of the differences that lenders will observe are as follows:

Borrower Profile

Whilst the peer-to-peer lending market can trace its itself back to beginnings in the personal loan market, much of today’s peer-to-peer lending activity is focused primarily on the business lending market and, in particular, the servicing of SME borrowers – companies in the £1-50 million turnover bracket.

Where some peer-to-peer ISA providers lend exclusively to SME businesses, others focus on servicing the retail lending market or backing property loans. Retail borrowers look to peer-to-peer lenders for lower rates than the traditional high street banks can offer and are matched directly with investors whose risk appetites are paired with the risk that the peer-to-peer lending platform assigns to each would-be borrower. Property developers seeking short or long-term finance for property deals and SMEs seeking funding either for day-to-day working capital purposes or for one-off projects are also drawn to the relatively rapid manner in which peer-to-peer ISA providers can risk-assess, approve and finance such projects.

Security

Investors should ensure that they understand the risks specific to each peer-to-peer ISA provider.

Some platforms retain internal contingency funds that are intended to safeguard investors from defaulting loans; others attempt to mitigate risk by spreading capital across an assortment borrowers – a process which can in some cases be fully automated from the lender’s perspective. Other platforms require that borrowers pledge an asset as security against the loan – an asset such as property or land – which could then be used to recover funds for lenders upon non-repayment of the loan. Some platforms are set up in such a manner that the loans are insured.

Differing borrower credit check processes

Each platform will carry out credit checks in order to help assess the risk attached to each and every potential borrower. Whilst these processes will typically be underpinned by information gathered from central credit reference agencies, each peer-to-peer ISA operator will have its own internal credit risk assessment policy and rules by which it determine who receives a loan offer and on what terms. Whilst these internal credit checks are likely to be similar in nature, the process of analysis, assessing and pricing risk will be unique to each peer-to-peer platform.

Other considerations

There are a number of other key areas that investors should consider when choosing a peer-to-peer lending ISA provider – and whilst the scope of this web page is not enough to cover this process in full detail, some of the high-level considerations available to the prospective investor are as follows:

Default risk

Default rates vary both between platforms and between individual loans within any given platform and, as with all forms of investing, the value of your investment can go down as well as up.

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Peer-to-Peer ISA Risk

No form of investment is entirely free of risk; the art is in managing that risk in a manner which is satisfactory to the investor. When considering a peer-to-peer lending ISA, an investor (or his or her advisor) must assess the risk appetite against known and unknown risks, in order to determine whether and in what manner it is worth investing.

The risk of borrower default can never be entirely eradicated – although it could be argued that borrower diversification and spreading one’s capital across a large number of borrowers could go a long way to minimising the risk faced where any one individual borrower defaults on his or her repayment obligations.

Following on from this, one must consider how the peer-to-peer lending market (and the ISA operators within it) might perform in the event of an economic downturn. The recent growth in peer-to-peer lending activity has yet to experience an economic downturn of a similar magnitude to the 2009 financial crisis, and it would be impossible to predict how both business and personal loans would perform in such a situation. It is likely however that we would experience differing returns across the various peer-to-peer lending ISA providers; this would be a function of each platform’s underlying stability as well as its approach to risk assessment, loan pricing and sector exposure, amongst other factors.

Complications of diversification

The risks of investing in any one asset class have been proven time and again, and for inexperienced investors, the credit analysis and other information that some peer-to-peer platforms provide to potential lenders, combined with a lack of automatic diversification by the ISA provider itself, can often make the process of diversifying investor funds across multiple borrowers challenging – even in the presence of extensive borrower data and information.

Differences in risk bandings

Although many platforms have risk gradings to group borrowers, such banding are not always directly comparable across the differing ISA platforms, meaning that a borrower might be graded at a different risk level depending on which platform he or she chooses to approach. The “risk band A” from one peer-to-peer lending ISA could be the equivalent of another provider’s “risk band 2”. Be aware that both the banding system and its parameters will very likely vary from platform to platform.

Lack of Financial Services Compensation Scheme (FSCS) protection

Whilst the Financial Conduct Authority is in the midst of seeking views on introducing FSCS coverage for loan-based crowdfunding, it remains the case that peer-to-peer lending ISAs are not protected under the FSCS, even though the platform itself will need to be FCA regulated in order to operate. The scheme would typically compensate up to £85,000 per person, however with peer-to-peer lending the only likely instance of compensation might be in such an instance as investors having received ‘unsuitable advice’ from a regulated advisory firm to invest in a peer-to-peer scheme. Note again that, defaults remain exposed and are not covered by FSCS compensation.

Although some platforms hold internal ‘reserve funds’ to provide lenders with a ring-fenced form of protection when a loan cannot be fully recovered, these are non-statutory and operated entirely at the individual platform’s discretion. Reserve fund policies could change over time and it is not necessary that claims against these funds have to be automatically paid out. It is also true to say that certain platforms which do not provide a formal internal reserve fund might seek to mitigate borrower risk in other ways – such as by insuring the debt.

Single lender limits

Legislation from HM Revenue and Customs (HMRC) – from whom firm approval is required alongside approval from the FCA – stipulates that only peer-to-peer lenders are able to offer peer-to-peer lending ISAs. Hence, investors will only have access to the individual loan book of that individual lending platform.

This is in stark contrast to a ‘Stock and Shares ISA’ where investors can spread investments across a variety of funds from an assortment of managers. If a third-party platform/broker were to become the ISA manager, investors could spread investments in the same way, providing the opportunity for further diversification and spreading of risk – but this has not yet happened.

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ISA Rates

Are advertised peer-to-peer rates real?

The returns received by peer-to-peer investors will hinge on a number of factors and of key consideration should be the extent to which default risk could reduce the overall return on capital. The gross interest yield advertised may very well be presented before platform management fees and bad debts have been accounted for.

Early access

Unlike many forms of cash saving – including many traditional Cash ISAs – with peer-to-peer lending your capital is effectively tied up during the course of the underlying loans. In some cases, where an investor wishes to access to their money ahead of the underlying loans maturing, the peer-to-peer ISA provider may offer the investor the ability to sell their loans – either in full or in part – to a new investor. This matchmaking process takes place in a “secondary market”, operated within the peer-to-peer ISA platform, although investors should note that generally speaking, early sale of a loan (whether in full or in part) will typically come at a cost – there may be a discount applied to the amount that the new investor pays for the loan, and the peer-to-peer platform itself may choose to take a handling fee.

Speed of deployment

Sometimes, in circumstances of larger investment deposits, funds are loaned gradually over a number of weeks or months in order to maintain both borrower creditworthiness and interest yield. A number of peer-to-peer platforms state that no interest will be paid to investors on funds that have not been deployed.

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Automatic diversification

Peer-to-peer is and always has been a financial technology innovation, and it continues to evolve as the sector grows and evolves. A number of peer-to-peer lending platforms use automation to aid investors through an automatic bidding process which automatically diversifies investment for lenders across multiple loans. This is a particularly useful tool for people with limited ideas on what they’d like to invest in, or for those with little time, or simply those wishing to avoid the need to personally manage the underlying constituent loans which collective comprise their peer-to-peer investments.

There has been strong demand for peer-to-peer lending ISAs despite the perceived risk and a perception of wariness amongst the financial adviser community. Whilst regulatory approval has been controversially slow and deliberate for peer-to-peer lending ISAs, this is potentially the coming-of-age era for the peer-to-peer lending sector.

Investors have been given compelling investment prospects, and borrowers could benefit from what could be a seismic injection of peer-to-peer funding, stimulating the SME sector and subsequently the wider economy. In all cases, investors must weigh up their own individual risk appetites and circumstances, and investigate all available options, before investing.

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