New type of ISA offering 8.7% interest: What you need to know

The innovative finance ISA: the opportunities and risks

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On April 7, for the first time in years, you'll be able to get 8.7% interest on your ISA. And it could break them.

That's because a new type of ISA is launching. One that lets you take your money and have it lent out directly to people and businesses in the UK, rather than hand it to banks who do that for you.

See also: Get up to date on ISAs

See also: How to pick a savings account

This "peer-to-peer" model has been around in the UK for more than a decade, it cuts the banks out of the equation and lets people get well-priced loans on one side and good interest on their money on the other.

It's also remarkably resilient – so far at least – with the bigger firms riding out the credit crunch and great recession a lot better than more traditional banks.

It's great news, as from April you'll be able to invest in them with an ISA – meaning your interest is tax free and you can transfer from an existing ISA.

Or it could break them.

The massive problem with peer-to-peer ISAs

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All this cash and no one to give it to...

Over the 12 years since the first peer-to-peer lender launched, it's been a success story.

People like the idea that they are giving money, not to a faceless bank and its millionaire bosses, but to a person or business that needs it.

The industry has systems in place to minimise the risk of you losing money if the person you hand cash to defaults (often either spreading money you put in between many borrowers, or sometimes having a fund in place to fill any gaps if people miss payments) – and over the years more than £7billion has been invested this way.

That's impressive, but £7billion is a drop in the ocean compared with the amount of cash we have saved in ISAs.

Worse, while the money in peer-to-peer has built up slowly over the years, people move their ISA money en-masse.

The "ISA season" – at the start of April – sees people rush to move their ISAs to the best-paying account as fixed-rate deals expire and people are prompted to look for a better home for their cash.

All of a sudden that will become a peer-to-peer account and the scale of the money involved, as well as the fact people move at once, means demand for these ISAs could massively outstrip supply.

Peerless savings rates

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Your money will grow faster in peer-to-peer

This is an extra problem when you look at the rates being paid by peer-to-peer providers.

FundingCircle offers 7% variable, RateSetter 5.5% fixed, LandBay 3.75% expected returns, and a host of others offer far more.

The biggest providers (and everyone listed above) are also listed on comparison sites – meaning people don't even need to go hunting for them, they just head to the place they've always gone to switch their ISA.

Not all of the big peer-to-peer operators will have an ISA product ready on Friday, but plenty will and many others are working on one.

There is some risk attached to these rates, but when the best-buy cash ISA offers just 1.05%, even the least risky peer-to-peer ISA triples your returns.

The problem then? Each of them needs to pair the money you pay in with someone who wants to borrow it.

If just 10% of the money we have in ISAs moves into these incredibly lucrative accounts in April, that will more than double the total amount that has EVER been lent out through them.

Where will they find the borrowers?

What happens if millions move at once

It won't be the first time demand has outstripped supply at a peer-to-peer lender – but it might be the biggest mismatch.

And the result? Depending on the firm you choose, money will be queued - meaning people don't earn interest while the provider tries to find someone to give it to - rates could well drop and many others will be told they simply aren't allowed to open one.

"We're a marketplace so we have to manage supply and demand," a Zopa spokesman told Mirror Money.

"Our priority is always to ensure that queue lengths for money waiting to be matched remain acceptable – whether that means putting in place a waiting list or a platform limit – because we don't think it's fair for investors to wait too long to have their money lent out."

Where is it queued? We asked LandBay, who are already seeing savers flood to their ISA.

"In the case where we have 'too much coming in' we would simply queue investors until we had more loan parts for them to fill, or until they could replace withdrawals via the secondary market [where people can cash in their money early]," a spokesman told Mirror Money.

"Investors can withdraw queued funds at any time and queued funds sit in our client account with Barclays so they are FSCS protected."

Rates are also set to fall – meaning the fantastic 8.7% returns could disappear fast.

"If more investors start to lend, the supply of money increases, and – all other things being equal – the rate that borrowers pay should drop as a result," a spokesman from RateSetter – who aren't currently offering a IFISA – told Mirror Money.

Neil Faulkner, of peer-to-peer ratings and research agency 4thway.co.uk, predicts that lenders could set a "floor" - so while interest rates might drop, they won't disappear or fall below those offered by cash ISAs.

"I don't think most platforms will allow the markets to dictate interest rates completely without a lower limit," he told Mirror Money.

But that doesn't mean you won't lose out.

"Whether the platforms set minimum interest rates or not, if too much cash is allowed to flow in it could be left uninvested for longer," he added.

The final option is for peer-to-peer sites to simply stop letting people open new accounts to transfer more money in - at least until they have enough people lined up to borrow it.

"If [a peer-to-peer site] is attracting too much investor money merely by offering an IFISA: it can stop advertising for investors and move its advertising budget to attract borrowers. I have seen platforms do this before," Faulkner added.

Should you just steer clear then?

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Will you lose a slice of your money?

Some 10million Britons have money in cash ISA accounts, earning pitiful returns. Peer-to-peer accounts would let many of them actually start to earn decent rates of interest again.

But they won't be for everyone – the risk you can lose money is greater than with a cash account and your money's not protected in the same way it is with standard accounts, where the first £85,000 is guaranteed to be safe.

That means many will be unwilling to leave the safety of a traditional cash ISA.

However, for people willing to take on a little risk in reward for far higher interest, the new innovative finance ISA lets you do that with part – or all – your savings and then switch back to a cash ISA later if you need.

How to move safely AND get a great rate

Step one is to understand the risks involved. Different sites have different ways of protecting your cash from borrowers missing payments, they also lend to different sorts of people.

If safety is your prime concern, 4thway.co.uk has a comparison tool, letting you see the pros and cons of different IFISAs.

Bit whichever one you choose, your cash will be less protected than if it's in a traditional savings account or ISA.

As such, it's probably a good idea to only transfer some of your money across, rather than your entire life savings.

If you do go for the rate, then you might want to move quickly to get ahead of the problems too many people switching to them could cause.

We'd suggest registering your interest now, ahead of launch, once you've decided which platform is for you. Some providers – including Landbay – will let you transfer cash into an ISA account now, ahead of launch.

However, it might also be wise to wait a few months – that way you can see any teething problems following the initial launch, and take a considered approach to picking where to move your money.



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