IFISAs: What Are The Risks?

The key risks in IFISAs are:

  1. Psychological risk: your own greed and fear.
  2. Concentration risk: you don't spread your money across lots of loans and P2P lending sites.
  3. Credit risk: borrowers don't repay you.
  4. Platform risk: the P2P lending site (the “platform”) goes bust and its wind-down is not perfectly managed.
  5. More platform risk: the P2P lending site doesn't go bust but decides to wind down P2P operations anyway.
  6. Risk of fraud or negligence.
  7. Risk of crystallising losses: selling into a loss, sabotaging your own investments.
  8. Liquidity risk: the risk that you're unable to get your money back swiftly, even if there's an easy-access feature.
  9. Cash drag: lost capacity to earn from money that sits unlent.
  10. Inflation risk: reduced real earnings due to rising prices.
  11. Legal and tax risks: reduced earnings due to legal or tax changes.
  12. Risks from cybercrime.
  13. Risks from higher costs.
  14. Inertia risk: risk of being tied in because the increased effort of switching IFISAs.

The first 12 of the key risks in P2P IFISAs are covered in The 13 Key Peer-To-Peer Lending Risks, since IFISAs and regular P2P lending accounts share most of the same risks. (One of those 13 risks doesn't yet apply to any IFISAs, namely currency risk, which is relevant when you're lending in a foreign currency only.)

Most people are unable to lend enough money to be bothered by taxes in a regular P2P lending account, but it can happen. (Read How Is Peer-to-Peer Lending Taxed?)

The main difference between a P2P IFISA and a peer-to-peer lending account is simply that lending in an IFISA is always completey tax-free.

Yet:

There are two risks exclusively applicable to P2P IFISAs: higher costs (risk 12) and greater inertia risk (risk 13). And there's also one extra feature that reduces the risk. These items are not covered in the P2P lending key risks guide, so let's go through these one at a time.

12. IFISA risks from higher costs

Where you are charged extra to lend through an IFISA, it will always mean higher risks.

Here's an example. Let's say that the borrowers pay interest rates of 9%. And a peer-to-peer lending provider takes a cut from the middle to cover the costs of vetting borrowers, advertising, administering loans and so on, so that the lenders receive 6.5% before bad debts.

If you want to wrap your lending up in an IFISA, let's say the provider charges you an additional one percentage point, even though you're lending in exactly the same loans. So that means you'll earn 5.5% before bad debts.

The more that costs eat into your returns, the closer you'll be to making a loss in a bad year. So you need to watch out for any extra layer of charges when your lending is wrapped in an IFISA.

The good news is that the vast majority of IFISA providers do not charge any more for you to lend through an IFISA than they do for their ordinary peer-to-peer lending accounts.

Also, if you're one of the minority of people who would end up being charged taxes in a regular P2P lending account, additional IFISA fees are not likely to be as high as the tax you are charged.

You might have to pay a small additional fee for some administrative items. For example, you might pay a fee to transfer your money out to another ISA. This normally shouldn't have much of an impact on you though and most P2P lending companies don't charge these fees.

You still need to watch out for regular ongoing additional fees with some IFISA providers, which can sometimes be one percentage point or more. The impact of 1% IFISA fees every year for 20 years could cost you £3,000 or more in winnings on a £5,000 initial lending pot. That's £3,000 less interest to cover potential bad debts.

13. Inertia risk: the risk of being tied into IFISAs

Lenders have the freedom to choose whether they want to stick with their current IFISAs after their loans have been repaid or sold, or whether they want to move on.

However, busy people with jobs, families, hobbies and stresses to deal with tend to put off decisions when it's a bit of a chore. This is sometimes called “inertia risk”. In other words, through your own inactivity, you're tying yourself to the same IFISA providers.

Switching IFISAs is a bit more of a chore than switching peer-to-peer lending accounts. After selling your loans or waiting for them to be repaid, you often then need to complete a paper form and wait several weeks for your money to transfer to other IFISAs.

This can be off-putting, so it's up to you to ensure your own busy-ness – or laziness – doesn't lead to you doing nothing, when it's time for you to do something.

One way IFISAs lower the risks

There's one way that IFISAs can lower the risks for lenders.

This applies to additional-rate tax payers. It could also apply to basic-rate and higher-rate payers, if the amount of interest you're earning through both lending and savings accounts is higher than your Personal Savings Allowance. (£1,000 for basic-rate payers and £500 for higher-rate payers. Read more on those limits in How Is Peer-to-Peer Lending Taxed?)

Since you're never taxed on any of your profits in IFISAs, this gives you an additional buffer of winnings for future years when your returns might be closer to zero, e.g. during a severe recession and property crash.

Potentially, especially if you like to lend in higher-risk loans, the extra winnings you keep by dodging taxes through an IFISA might ensure that you don't make a loss.

Not all IFISAs are P2P lending

4thWay focuses exclusively on peer-to-peer lending, including IFISAs that do P2P lending by our own definition – which is most of them. In short, anything that isn't direct lending between you and the end borrower, or that doesn't use a sound, legitimate legal device to effect the same in practice, has nothing to do with us.

Some IFISAs are not P2P lending by this definition and therefore they contain at least one additional risk that we don't usually cover on 4thWay, being outside our jurisdiction.

But you're probably curious so, just for your info, that additional risk comes about because you're lending to the IFISA provider or to closely linked businesses, and not directly to each of the individual borrowers.

Therefore, the risk is that, if the IFISA provider collapses, you won't get all your money back because borrower repayments will not all be repaid to you. Even though you lent them the money!

Instead, other businesses that were owed money by the IFISA provider will also get a slice of the repayments. So, the provider's bank gets some of it to cover part of the IFISA provider's outstanding overdraft and loans. And the IFISA provider's suppliers, who haven't been paid yet, will get a cut as well. And probably others owed money by the business will also have a claim.

Articles linked to above:

The 13 Key Peer-To-Peer Lending Risks.

10 Ways To Get Your P2P Lending Money Back!

How Is Peer-to-Peer Lending Taxed?

Read everything you need to know about IFISAs in the IFISA Guide.

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