What is an Innovative Finance ISA?

First introduced in 2016, Innovative Finance ISAs (IFISAs) are perhaps the least well-known of the four main types of ISA available. Here’s what you need to know if you’ve ever wondered what an IFISA is and what risks are involved.

An IFISA is a type of savings account that applies a tax-wrapper around peer-to-peer loans and crowdfunding debentures, preventing you from having to pay capital gains and income tax on any returns. Instead of going through a third-party like a bank, funds in an IFISA are lent out directly to borrowers such as businesses, individuals and property developers. An ideal outcome is that your investment is returned in full plus interest at the end of an agreed term, but this isn’t guaranteed.

Like any form of investing, your capital is at risk when choosing to put money into peer-to-peer loans.

One risk you face is the borrower defaulting, which is when an individual or business is unable to repay your loan. Where they are unable to repay the loan in full, you may lose part of your original investment. This means you could end up losing out on all your investment if the borrower is unable to repay any of the loan.

While some investment companies will have reserve funds to protect investors in these circumstances, this is not always the case. There’s also the risk if multiple debtors default at once that the reserve funds will be inadequate to compensate all investors.

Unlike other types of ISAs and savings accounts, funds in IFISAs aren’t protected under the Financial Services Compensation Scheme (FSCS), meaning you could end up losing your money if the company you’ve invested through goes out of business.

IFISAs are one of four types of ISA available, with each having their own merits and drawbacks. For a full overview, see our guide on the different types of ISA.

An alternative for those looking for an investment product is a stocks and shares ISA. This type of ISA lets you earn tax-free returns when investing in funds, bonds and shares. Like IFISAs, with stocks and shares ISAs there is the chance of making larger returns on your investment, but the trade-off is that you’re putting your capital at risk.

Because of the volatility of the stock market, there’s always the chance that your investment could fall rather than rise, which is why stocks and shares ISAs generally carry a greater risk than other types of ISA. However, while IFISAs aren’t protected by the FSCS, the scheme does cover funds up to £85,000 in a stocks and shares ISA. This means your money would be protected if your provider were to collapse. Note that this protection doesn’t cover losses on investments that perform poorly. You can visit our tables to compare the best stocks and shares ISAs currently available.

Meanwhile, if you’re simply looking for somewhere to maximise your savings with a tax-wrapper, a cash ISA may be a good alternative. There are many different types of cash ISA to choose from, suiting a wide range of different circumstances. Some factors to consider include interest rate paid, the amount of notice needed to make a withdrawal, and how many withdrawals you can make. We have charts that can help you compare different cash ISA rates, while once a week we publish an overview of the best ISA rates available.