Dear Rick:
I need some sound advice and I hope you can help me. I am in my mid-70s and a widow. Financially I am comfortable, pension and Social Security covers most of my expenses. My granddaughter has asked me to loan her some money. Her parents said they were not in a position to help. I would like to help but my question is do you think I can afford it? To cover my current expenses, including going to Florida in the winter, I need about $1,000 a month from my portfolio. In addition to my pension and Social Security, I have about $500,000 in miscellaneous investments. My house is free and clear and is worth about $200,000. My granddaughter wants to borrow $50,000 and as much as she says she will, I assume I will not be paid back. Do you think I can afford it?
Char

Dear Char:
I love the fact that you recognize when you loan money to family members there is a decent chance you will not be repaid. Therefore, you are following the right methodology in determining whether you can assist your granddaughter or not by asking yourself whether you can afford to lose the money if you are not repaid. All too often when people loan money to family members thinking they will be repaid and then are not, it causes all sorts of financial and family problems.

In reviewing your situation, I am a firm believer that you need a rising income the rest of your life. Our needs grow at a much greater rate than the reported inflation rate and we must be prepared for it. The thousand dollars a month you need from your portfolio today will only rise in the future. In addition, I believe it is important to recognize that we are all living longer and therefore, must plan to be around at least until our mid-90s. That being said, I believe that considering the size of your portfolio, you can loan your granddaughter the money and from a financial standpoint, whether she pays you back or not, it will not change your lifestyle. That does not mean you should not expect to be repaid; but, if you are not, you can still maintain your lifestyle.

In making my analysis, I assumed that your granddaughter would not pay you back and thus, your portfolio would be approximately $450,000. The fact that you would take an approximate three-percent-a-year draw from this puts you in good shape financially. Generally, if you take a draw from your investments greater than 3½ or 4 percent of your portfolio per year, you could run into issues down the road.

In reaching my conclusion, it is also important to keep in mind that you also have a cushion. The fact that your house is paid off provides you with an asset you can use. I do not necessarily recommend it today, but if situations change, somewhere in the future you can consider a reverse mortgage. The reverse mortgage can provide you with a substantial cushion.

In order to show your granddaughter that borrowing money is serious, I recommend that you have her sign a formal promissory note documenting the transaction. I find people take things more seriously when they are put in writing.

It is important to keep in mind that when you loan money to family and friends you should document the transaction. People have short-term memories and it is important that everyone understand the terms of the deal and the consequences of nonpayment. I believe the best way to do this is right from the onset by getting things in writing.

Good luck!

Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com