How to assess your Innovative Finance ISA provider

The end of the tax year is just a week away but there is still time to open an Innovative Finance ISA (IFISA).

Here are the key areas of due diligence P2P investors should do when choosing where to earn their returns tax-free.

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 firm’s permissions on the FCA financial register.

This will tell you what a platform is allowed to do and if its permissions are current.

There is no Financial Services Compensation Scheme (FSCS) protection, unlike using a Cash or Stocks and Shares ISA provider.

But using a regulated P2P lender for your IFISA means the platform has to follow certain standards on transparency, ensuring investors understand risks and users can complain to the Financial Ombudsman Service if there is an issue.

Read more: Which IFISAs are still accepting money this tax year

Type of lending

There are a range of different lenders within the P2P sector.

Investors can only hold one active IFISA during a single tax year but you could open another product to transfer old tax-free savings.

You can choose from P2P lenders providing property loans and finance for businesses, consumers and even students.

Make sure you understand the type of lending and who the money is going to, all of which should be explained clearly on a P2P lender’s website.

Secured v unsecured

Some platforms such as property lenders will offer secured lending.

This is where a loan is secured on an asset such as the underlying property.

Business loans may also be secured on a workplace asset but not all platforms provide this.

Other types of lending such as consumer loans are typically unsecured.

Read more: Record year for Folk2Folk’s IFISA

Unsecured loans may be seen as more risky as there is no asset that can be sold if a borrower defaults but there is also no guarantee that a property or asset sale will cover what is owed for a loan.

You can also minimise your risk by spreading money across a range of loans on a platform in the same way a stock market investor would back different shares.

Interest rates

Interest rates can vary from three per cent to 12 per cent.

Typically, 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 typically advertise its target rates on its website, these aren’t guaranteed as it will depend on any arrears and defaults in your portfolio.

Loanbook size

The exit of Funding Circle and Zopa from the market means there are very few billon-pound loanbook lenders in the market.

Only Assetz Capital has a loanbook worth more than £1bn.

The next closest is Folk2Folk with around £500m and then other providers have loanbooks closer to £200m.

Size isn’t necessarily an indicator of positive performance but it does suggest that a platform has experience and a track record in the market.

Read more: Invest & Fund records record IFISA openings

Lending strategy

The way a platform lends to borrowers could influence where you put your money.

Check how a platform assesses a borrower, the typical loan to value and any security taken to see if it reflects your risk appetite.

A low loan-to-value, typically around 60 per cent, may be seen as safer than a larger loan as it means the borrower has put in a high deposit so has more at stake if they fall behind on repayments.

However, platforms lending more may also offer higher rates and you could get a better return by taking more risk.

Track record

Past performance isn’t a guarantee of how a P2P portfolio will do in the future but it can be a useful indicator.

A P2P lender should have a statistics page where you can see its historical and predicted arrears and defaults as well as how good it is at recovering money and current interest rates being paid.

This should give you an idea of how volatile your investment could be and the likely returns you could get as well as ultimately whether an IFISA is worth the risk.