If you’re looking for somewhere to save your cash in a tax-free environment, you might be tempted by a cash ISA. But watch out, because some ISAs look like cash, but aren’t.
When is an interest-paying ISA not a cash ISA?
You probably know that you can take out a cash ISA or a stocks and shares one, up to a limit of £20,000. If you prefer, you can split your money between the two. But, in fact, there are more choices than just a cash or a stocks and shares ISA.
A relatively new form of ISA is an innovative finance ISA. An innovative finance ISA is an ISA that lets you lend money through peer-to-peer lending. Peer-to-peer lending is a way for you to earn interest by lending money to individuals, companies or projects that need loans.
How much interest do innovative finance ISAs pay?
Innovative finance ISAs pay interest rates of – typically – between 4% and 9% or more. That compares with an easy access best buy cash ISA interest rate of around 1.5%. You can get over 2.5% if you’re prepared to put your money into a five year fixed rate cash ISA.
If you find an ISA that pays interest at a much higher rate than this, it’s unlikely to be a cash ISA and you’re probably taking on quite a lot more risk.
SAVVY TIP: Unlike in a cash ISA, with an innovative finance ISA, your money isn’t protected by the UK’s savings protection scheme. This scheme is called the Financial Services Compensation Scheme.
How risky are innovative finance ISAs?
There are dozens of companies that offer innovative finance ISAs. They are riskier than cash ISAs (and may be riskier than some stocks and shares ISAs). Also, it can be harder to get your money out of them. With most stocks and shares ISAs, you can just cash them in whenever you want. It might not be the most sensible option if the stock market has just fallen sharply, and you may get less than you paid in. But there’s nothing to stop you doing it.
With an innovative finance ISA, you may not be able to cash in your ISA before the term is up. It all depends on the product and what you’ve actually invested in. With other innovative finance ISAs, you can cash them in, but you may be charged a fee. You may not be able to cash in your innovative finance ISA straight away, as the provider may have to find investors to buy your investment.
Where are innovative finance ISAs advertised?
Individual providers of innovative finance ISAs advertise their products, which is what you’d expect. But some organisations advertise online on platforms that look like ISA comparison websites. In some cases, they may not be.
SAVVY TIP: Watch out if you type ‘best ISA rates’ into Google or a similar search engine. Some sites that come up say they have ISAs that pay 8% interest or more. Having checked a couple of them, your money could be invested in hotel resorts or spas or energy production projects. It’s not that these investments are necessarily dodgy and you may well get the promised return. But you may be taking on more risk than you realise, and more than you feel comfortable with.
Always check exactly what your money is being invested in before you sign up.
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