Peer-to-peer Isas: what are they and should you invest?

From April, a new product joins the Isa family – the Innovative Finance Isa (If Isa) which could pay returns of around six per cent, far higher than traditional cash Isas. Here is everything you need to know about the new kid on the tax-free savings block.

What is an If Isa?

From 6 April, If Isas will allow you to use your annual Isa allowance (which will be £15,240) to invest in peer-to-peer lending. The first accounts have been unveiled and offer tantalising interest rates of up to 5.7 per cent. Use an If Isa and you won't have to pay income tax on those returns. According to RateSetter, the first peer-to-peer lender to announce its Isa offering, a higher-rate taxpayer could save £376 a year.

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How do IF ISAs compare with Cash Isas?

The interest rates being offered so far are double that of the equivalent cash Isas.

RateSetter will be launching four If Isas in April, with a range of terms and interest rates.

So, the full £15,240 limit invested in an If Isa could make you almost £500 more than if you put it in a cash Isa.

With headline figures like that, it is hardly surprising a lot of people are considering taking out an If Isa. "Given the potential for significantly better rates on offer, it's no wonder that one in four cash Isa holders say they are considering opening an Innovative Finance Isa," says Rhydian Lewis, the chief executive of RateSetter.

However, there are drawbacks. In order to get those bumper interest rates, you are taking on more risk - in fact, the former head of the financial regulator said today he expects a wave of losses on these accounts that will make banks look like "genius lenders".

What is peer-to-peer lending?

This alternative form of saving has become increasingly popular in the low-interest rate environment of the past seven years. The idea is that peer-to-peer lending cuts out the middleman – the bank – when it comes to personal and business loans. You lend your savings to people looking for loans and they repay with interest. You do so through an online platform, so its all anonymous and prevents conflicts of interest.

The big risk is that the borrower won't repay and you'll lose your savings. This risk is mitigated by spreading your money across several loans. Also, most reputable peer-to-peer companies have a provision fund in place that will cover your savings plus interest if one of your borrowers were to default.

Another risk with If Isas is that unlike cash ISAs, they will not be covered by the Financial Services Compensation Scheme. This means if the provider of the If Isa goes bust, you could lose your savings. As yet, no British peer-to-peer lender has collapsed, but they haven’t really been tested yet. Only one, Zopa, existing during the financial crisis of 2008.

Should I invest?

That is really down to you. The big interest rates are certainly tempting but you have to decide if you are comfortable with the additional risk.