The end of the fiscal year is only a week away but there is still time to open an Innovative Finance ISA (IFISA).
Here are the key areas of due diligence that P2P investors should do when choosing where to earn their tax-free income.
Is your IFISA provider regulated?
All peer-to-peer lenders are supposed to be regulated by the Financial Conduct Authority (FCA).
You can check a company’s authorizations on the FCA Financial Register.
This will tell you what a platform is allowed to do and if their permissions are up to date.
There is no Financial Services Compensation Scheme (FSCS) protection, unlike using a cash or stock and stock provider ISA.
But using a regulated P2P lender for your IFISA means that the platform must meet certain transparency standards, ensuring that investors understand the risks and that users can complain to the Financial Ombudsman Service if something goes wrong.
Read more: Which IFISAs are still accepting money this tax year
Type of loan
There is a range of different lenders in the P2P sector.
Investors can only hold one active IFISA in a single tax year, but you can open another product to transfer old savings tax-free.
You can choose from P2P lenders that offer home loans and financing to businesses, consumers, and even students.
Make sure you understand the type of loan and who the money is for, all of which should be clearly explained on a P2P lender’s website.
Secure v Insecure
Some platforms such as home lenders will offer secured loans.
This is where a loan is secured against an asset such as the underlying property.
Business loans can also be secured against a workplace asset, but not all platforms offer this.
Other types of loans, such as consumer loans, are generally unsecured.
Read more: Record year for Folk2Folk’s IFISA
Unsecured loans can be considered riskier because there is no asset that can be sold if a borrower defaults, but there is also no guarantee that a sale of property or assets will cover what is owed for a loan.
You can also minimize your risk by spreading the money across a range of loans on a platform in the same way a stock investor would back different stocks.
Interest rate
Interest rates can vary from 3% to 12%.
Generally, higher interest rates mean more risk, so an investor should be prepared for potential losses, but there is also a chance of a decent return.
A P2P lender will usually advertise their target rates on their website, these are not guaranteed as it will depend on the arrears and defaults in your portfolio.
Loan book size
The exit of Funding Circle and Zopa from the market means that there are very few billion pound lenders in the market.
Only Assetz Capital has a loan book worth more than £1bn.
The next closest is Folk2Folk with around £500m, then other providers have loan books closer to £200m.
Size is not necessarily a positive performance indicator, but it does suggest that a platform has experience and track record in the market.
Read more: Invest & Fund records record openings of IFISA
Lending strategy
How a platform lends to borrowers can influence where you put your money.
Check how a platform rates a borrower, the typical loan to value, and any collateral taken to see if that reflects your risk appetite.
A low loan-to-value ratio, usually around 60%, can be considered safer than a larger loan, as it means the borrower has made a high deposit and therefore has more at stake if they fall behind in its repayments.
However, platforms that lend more may also offer higher rates, and you might get a better return by taking on more risk.
Background
Past performance is not a guarantee of future performance of a P2P wallet, but it can be a useful indicator.
A P2P lender should have a statistics page where you can see their historical and projected arrears and defaults as well as their ability to collect money and the current interest rates paid.
This should give you an idea of the volatility of your investment and the likely returns you could get as well as whether an IFISA is worth the risk.
