Thousands of investors who backed peer-to-peer lending in their Isa to get tax-free returns have seen the riskiness of their investment rise today after the Bank of England increased the cost of borrowing.

Interest rates were raised by 0.25pc to 0.75pc, the first hike above 0.5pc in more than nine years.

Savers and those looking to buy an annuity, who have suffered from dismal returns because of ultra low interest rates, are on course to benefit from the increase.

But for investors who have put £300m into a new generation of schemes that have never been tested in a time of interest rate rises, experts have said the news should come as a warning to look closely at what they are holding.

Investors in peer-to-peer loans, which were allowed inside an Innovative Finance Isa since April 2016, are at particular risk.

Justin Modray, chief executive at advice firm Candid Money, said P2P investors need to check as soon as possible if the loans they have backed are on variable rates of interest that increase with the Bank’s base rate.

“Floating rate P2P loans could be a concern. Even if the P2P loan is on a fixed rate and so won’t increase, if a P2P borrower has borrowed elsewhere, and there is a high chance they have, those loans could be on variable rate so they become more stretched and we could start to see people default on their P2P loans.”

Peer-to-peer lending is an alternative to taking out a loan from a traditional financial institution like a bank. Most loans are personal loans, which borrowers can use for thing such as debt consolidation, home improvement, or small business loans. Investors loan the money and in return they receive an income of the interest, then the return of their capital at the end of the agreed loan period.

With interest rates on savings accounts and bond yields at record lows since 2009, P2P lending promised a better income, with Innovative Finance Isas offering tax-free returns of between three and seven per cent, according to trade body the Peer-to-Peer Finance Association.

However City watchdog the Financial Conduct Authority last week announced it was planning to ban P2P lenders from approaching average investors directly, after finding they were not always given clear or accurate information about where they were putting their money, leading them to buy unsuitable financial products.

The FCA said P2P lending platforms must do more to explain to investors the true investment risk they are exposed to, and pay them fairly for the risks they are taking.

Mr Modray said: “P2P is new. It hasn’t gone through a full economic cycle, a downturn or rising interest rates. We could see people failing to repay their loans quite considerably.

“There is nothing inherently wrong with P2P investing but I fear people are investing blindly and naively. It is not the same as a current account and people need to appreciate they may not get their money back.”

From a survey of 4,500 P2P investors, the FCA found 40pc had invested more than their total annual income and, of those, half had invested more than double their annual income.

Stephen Findlay, chief executive of BondMason, a direct lending and P2P loan platform based in Harpenden, said when reviewing P2P lending platforms for his own business launch in 2015, out of the 80 he investigated he only had confidence in 13.

Central to his concerns was the platforms were not carrying out enough research into the ability of borrowers to pay back the loans investors were supporting.

He told Telegraph Money: “We’ve started to see some of these credit performance failures crystallise, such as Urica (France) and Argon Credit (US), manifesting themselves in investment performance issues for some of the lending funds such as P2PGI and Ranger Direct, the latter being forced into a wind up by activist shareholders as a result.

“We expect more to follow, but we don’t feel this should undermine the viability of direct lending as an asset class, if it is accessed in a conservative and considered way.”

The UK crowdfunding market, of which P2P lending is a part, increased from £267m in 2012 to £3.2bn in 2015, Nesta, (the National Endowment for Science, Technology and the Arts), which looks at innovation trends, reported last year.

Data from the Peer-to-Peer Finance Association found 28,000 Innovative Finance Isas have been opened on its members’ platforms, with more than £300m already under management in the first year they have been widely available (few platforms had gained authorisation at the 2016 launch of the Innovative Finance Isa).

laura.miller@telegraph.co.uk

Warning: Nothing in this article should be construed as advice. Your capital is at risk.

Link to article: https://www.telegraph.co.uk/investing/isas/interest-rate-rise-peer-to-peer-isa-investors-face-new-risks/