IFISAs: What Are The Risks?
This page was last updated on 27 June, 2019
The risks in IFISAs include:
- Psychological risk: your own greed and fear.
- Concentration risk: you don't spread your money across lots of loans and P2P lending sites.
- Credit risk: borrowers don't repay you.
- Platform risk: the P2P lending site (the “platform”) goes bust and its wind-down is not perfectly managed.
- Risk of fraud or negligence.
- Liquidity risk: the risk that you are unable to get your money back swiftly, even if there is an easy-access feature
Those are the big six.
The first five key risks in IFISAs are covered in The Five Key Risks In Peer-To-Peer Lending, since they are usually identical in P2P lending as in IFISAs. Similarly, the sixth key risk in IFISAs is covered in 10 Ways To Get Your P2P Lending Money Back!
Most people who use IFISAs to lend their money in are taking part in peer-to-peer lending. The difference is simply that the lending is wrapped up in a completely tax-free type of lending account.
Yet there are two extra risks applicable to P2P IFISAs – higher costs and “inertia risk”. And, there is also one extra feature that reduces the risk. These three items are not covered in the P2P lending key risks pages. So let's go through these one at a time:
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 10%. Let's say that a peer-to-peer lending provider takes a cut from the middle 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 will 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.
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.
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.
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 is a bit of a chore. This is sometimes called “inertia risk”. In other words, through your own inactivity, you are 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.
What's worse about IFISAs is that some lenders could too easily end up putting too much money into just one, due to the apparent difficulty in opening several accounts in a short space of time.
There are restrictions on the number of ISAs you can put new money into in one year. This reduces the number of loans and P2P lending sites that you lend across, which increases your risks if you don't stagger your money or save and invest some of it elsewhere.
In an attempt to combat that, there are some aggregators offering IFISAs that combine loans from different peer-to-peer lending sites. But all of those IFISAs come with the aforementioned higher fees.
There are better solutions, however. If you want to spread your money around lots of IFISAs more quickly, read How To Lend Across Multiple IFISAs In One Year!
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 are 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 are not taxed on 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 – which is most of them. Anything that isn't direct lending between you and the end borrower has nothing to do with us.
But some IFISAs are not P2P lending and therefore they contain at least one additional risk that we don't usually cover on 4thWay, being outside our jurisdiction.
But you are probably curious so, just for your info, that additional risk comes about because you are lending to the IFISA provider, 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 owed to you.
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.
Read everything you need to know about IFISAs in the IFISA Guide.
For more, read our 10-page guide.
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Independent opinion: the opinions expressed are those of the author and not held by 4thWay. 4thWay is not regulated by the ESMA or the FCA, and does not provide personalised advice. The material is for general information and education purposes only and not intended to incite you to lend.
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