Jeff Salway: Isa to boost peer-to-peer lending demand

Demand for peer-to-peer lending is about to soar as the launch of the innovative finance Isa sends the market into the savings mainstream.
Savers can put up to £15.240 each year into an Isa, rising to £20,000 in April 2017Savers can put up to £15.240 each year into an Isa, rising to £20,000 in April 2017
Savers can put up to £15.240 each year into an Isa, rising to £20,000 in April 2017

Wednesday’s introduction of the innovative finance Isa, which will allow peer-to-peer (P2P) products to be held in tax-free Isa wrappers for the first time, comes as the rates on high street savings accounts continue to fall.

P2P platforms allow savers to earn interest of more than 4 per cent by lending to people or businesses wanting loans. The market has emerged during a period of record low interest rates, benefiting from demand for an alternative to the poor returns available from traditional savings accounts. More than £2.2 billion was lent by P2P firms last year, double the total reached by the end of 2014.

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Their inclusion in Isas from Wednesday is expected to further boost their popularity, with Morgan Stanley estimating that the market could be worth £15 billion by 2020.

Up to £15,240 can be saved in an Isa each year, rising to £20,000 in April 2017, and savers will be able to transfer money into the innovative Isa from existing Isas.

Returns on ordinary cash Isas have plunged in recent years. Almost 70 rate cuts in February saw the average easy access Isa fall to an all-time low of just 1.05 per cent, Moneyfacts figures show.

In contrast, savers can currently earn up to 5.9 per cent with RateSetter, up to 7.3 per cent with FundingCircle (which allows individuals to lend to small businesses) or up to 6.5 per cent with Zopa.

Other providers include ThinCats (another peer-to-business platform), Lending Works and LendInvest (a P2P short-term mortgage lender). The launch of the innovative Isa will attract bigger names to the market, with Hargreaves Lansdown among those preparing to enter the fray.

“Peer-to-peer is an ever growing sector and these brands offer some outstanding rates of interest for savers, but this does come with risk,” said Rachel Springall, spokeswoman for Moneyfacts.

“By fixing for longer, savers can get better rates – however in times of uncertainty some savers may be wiser to consider easy access accounts so they can withdraw their money quickly, either to respond to market movements or for emergencies.”

The innovative Isa will be launched the same day as the new personal savings allowance, which will allow basic rate taxpayers to earn £1,000 of interest before they have pay tax on it. This means savers will be able to hold P2P products outside an Isa and still not pay tax on their savings interest, noted Kevin Pratt, consumer affairs expert at Moneysupermarket.

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“It’s worth remembering that savers can split their annual £15,240 Isa allowance across different products, so for example they could put £8,000 in a cash Isa, £4,000 in an innovative finance Isa and £3,240 in a stocks and shares Isa,” he added.

But there are downsides too. The most obvious is that P2P products still won’t be covered by the Financial Services Compensation Scheme (FSCS) in the same way as products including traditional Isas. Savers will only have recourse to the FSCS or the Financial Ombudsman Scheme if they put money into a P2P scheme following a personal recommendation by a financial adviser, the FCA confirmed last week.

“FSCS protection is worth up to £75,000 in the event of an institution going bust, so those invested in P2P need to be aware that their money is at risk and, in an extreme situation, could be completely lost,” said Pratt.

P2P lenders do have their own safeguards in place, however. Robust checks on loan applicants have helped keep default levels below those on the high street banks, while savers are also protected by having their loans spread across multiple borrowers, ensuring they don’t lose their money if one or two borrowers go bust.

Most P2P have protection funds and keep lenders’ money in ring-fenced accounts. RateSetter, for instance, has an additional provision fund that increases with each loan matched and which is aimed at guaranteeing savers are returned all the capital and interest they are owed.

These arrangements vary with each lender, so it’s worth looking under the bonnet before getting started.

“If a provider defaults typically what would happen is that a ‘provision fund’ kick starts. Savers would be wise to look into the way a peer-to-peer provider lends so they can see how they diversify risk,” said Springall.

Not all P2P providers will be able to offer innovative finance Isas from Wednesday, however. Several providers have yet to receive the authorisation they need from the FCA, which is still working through a backlog of applications.