Net Present Value (NPV) and Your Mortgage Loan Modification

"Net present value" (NPV) indicates how much an investment is worth. In the context of a loan modification, lenders and mortgage servicers calculate the NPV to evaluate whether it is more cost-effective to modify a loan or foreclose.

General Eligibility Requirements for a Loan Modification

When a servicer (the company that manages the loan account for the original lender or current owner of the loan, called an "investor") evaluates a loan for modification, it generally looks at the following:

• the borrower's finances, including income, existing loan payments, and savings
• whether the borrower has suffered an economic hardship, and
• the borrower's ability to make modified payments.

In some cases, the servicer also runs an NPV test.

What Is an NPV Test?

After evaluating the borrower's financial circumstances, the servicer then sometimes (depending on investor guidelines) makes a comparison between:

• the estimated cash flow the investor will receive if the loan is modified, and
• the investor's cash flow if the home is foreclosed.

This evaluation is called an "NPV test."

How Does the NPV Test Work?

As part of the test, the servicer looks at the NPV of the proceeds expected from a foreclosure and subsequent sale of the property based on reasonable estimates of:

• the property's current fair market value
• costs to foreclose, repair, and maintain the property
• costs incurred in marketing and selling the property to a new owner (if a third party doesn't buy it at the foreclosure sale), and
• net sales proceeds.

The servicer will also calculate the NPV of the cash flow expected from a modification. The servicer will review certain information, including:

• income information for the borrower
• recent credit scores for the borrower
• the loan's interest rate (including whether a payment reset will happen if the rate is adjustable), and
• other mortgage debt information (like the unpaid principal balance, original loan amount, remaining term, and monthly payment information).

But the NPV test doesn't consider any claims the borrower might have, litigation costs or time expended to litigate, or any costs to society after a preventable foreclosure.

Foreclosure vs. Modification

The servicer compares the NPV for a foreclosure versus modification. Whichever is higher is the option the servicer will select.

If a loan modification makes sense from an NPV perspective, the lender will ensure that the borrower can afford the monthly payments and modify the borrower's loan. But if the investor would be better off financially after a foreclosure than a modification (called "NPV negative"), then the servicer generally won't modify the loan.

Why Use the NPV Test?

It might seem obvious that a lender or investor would make more money giving a borrower a modification with affordable payments rather than foreclosing and selling the property, perhaps at a loss, especially if the mortgage is underwater. But borrowers who get a modification often go into default (fall behind on payments) again sometime in the future. The NPV test estimates the likelihood that the borrower will default again and eventually end up in foreclosure anyway.

If it looks like a foreclosure will probably become inevitable even if the loan is modified, the servicer will likely go ahead with a foreclosure because it makes more financial sense to liquidate the investment sooner rather than later.

Loan Modification Denials Due to NPV

Under federal mortgage servicing law, if a servicer denies a trial or permanent loan modification due to an NPV calculation, the servicer must include the inputs used in the calculation in the modification denial notice. (12 C.F.R. § 1024.41(d), see official interpretation, #2).

If you receive a modification denial letter with NPV information and think the servicer made a mistake in its calculation—which can happen—discuss the results with your servicer and, perhaps, an attorney.

When to Seek Legal Counsel

If you're facing a foreclosure and have questions about the process or whether you have any defenses, consider talking to a lawyer. You should also consider contacting a lawyer if you're trying to get a modification but the servicer isn't complying with the law or is treating you unfairly. Legal violations might give you leverage in the modification process.

If you need help applying for a modification with your servicer, a HUD-approved housing counselor can help you at no cost.