RateSetter has launched an innovative finance Isa which could pay up to 6% in interest – but there are some risks.
With the new product form RateSetter, you could earn between 3% and 6% interest on your investment, depending on how long you lock your money away.
But these attractive returns could come at a severe cost. The new innovative finance Isa is not covered by the Financial Services Compensation Scheme (FSCS) – meaning savers run the risk of losing money if anything goes wrong.
Which? takes a look at how RateSetter’s innovative finance Isa stacks up and whether it’s worth investing in.
- Find out more: RateSetter review – find out how it stacks up
What is an innovative finance Isa?
An innovative finance Isa – sometimes referred to as ‘IFISA’ – is an Isa that contains peer-to-peer (P2P) loans.
- Find out more: innovative financial Isas explained
What is peer-to-peer lending?
Under peer-to-peer lending, individuals willing to lend money are matched with individuals or small businesses looking to borrow.
Savers invest their money through a peer-to-peer lending website.
To qualify for a loan, borrowers are credit checked by a credit reference agency and often have to pass a lender’s credit-worthiness test.
Some peer-to-peer lenders even allow you to choose the credit-worthiness of a borrower – so that you can choose to lend to a higher-risk person to at an increased interest rate, or a lower-risk person for more modest returns.
Check out our short video on peer-to-peer lending for more information.
- Find out more: peer-to-peer lending explained.
What does RateSetter’s innovative finance Isa offer?
RateSetter’s Innovative finance Isa allows you to invest up to £20,000 in a tax year.
It is a flexible Isa product, meaning you can withdraw money and replace it without using up your £20,000 tax-free savings allowance.
Say, for example, you put £10,000 into your innovative finance Isa and then withdrew £5,000. Under the rules, you could still deposit £15,000 without incurring tax.
Depending on the amount of time you invest your money with RateSetter, you could earn an average of 3% to 6% interest.
The shortest duration investment rolls over monthly with an interest rate of 3.1%. The longest is a five-year investment, which currently has an interest rate of 5.8%.
From April 2018, customers will be able to invest up to a further £20,000 in the 2018-19 tax year and transfer funds from other Isa accounts into their RateSetter innovative finance Isa as well.
The Isa is currently only available to existing customers and will open to the general public on 1 March 2018.
- Find out more: tax-free income and allowances.
Who else offers innovative finance Isas?
There are a number of innovative finance Isa products on the market.
RateSetter’s Isa rate positions it between its direct competitors LendingWorks, which offers up to 6% interest for investments lasting five years, and Zopa, which offers up to 4.6% interest.
The following table shows the current offerings of different innovative finance Isa providers.
- Find out more: which providers offer innovative finance Isas?
Is an innovative finance Isa a safe way to save?
Innovative finance Isas offer a higher rate of interest on tax-free savings, which can be tempting for some.
It is important to note, however, that the higher interest rate comes with higher risk, and there is a real possibility of losing your money.
Unlike traditional savings accounts, peer-to-peer lending websites are not covered by the FSCS, meaning that your savings are not guaranteed if your peer-to-peer lender goes bust.
The FSCS, which is a protects your money should anything happen to your bank, building society or credit union, will reimburse lost savings of up to £85,000 for individuals or £170,000 for couples per banking licence.
Instead of the FSCS, some peer-to-peer lenders, such as RateSetter, offer a compensation fund that will compensate you if a borrower can’t repay their loan. But there isn’t an infinite sum of compensation available, so some investors could ultimately end up losing money.
If you’re considering an alternative to Isas, some regular savings accounts – including First Direct, HSBC, M&S Bank and Santander – are all offering 5% AER for the first 12 months to existing account current holders.
These accounts usually have limits on how much you can deposit per month, typically between £250 and £500.
Fixed-rate savings accounts could also be an option if you are willing to lock your savings away for a set period (typically between one and five years). For example, the best five-year fixed interest rate is currently 2.46% AER from Secure Trust Bank.
For more information about savings option, take a look at our guide to cash Isa alternatives including stocks and shares Isas and premium bonds.
Updated 14 February 2018: Zopa retired their provision fund for all new lending in December 2017