“Net present value” (NPV) is an indicator of how much an investment is worth. In the context of a loan modification, lenders and servicers calculate the NPV to evaluate whether it is more cost effective to modify a loan or foreclose. (To learn what foreclosure is, how it works, and what options are available to you when facing foreclosure, see What Is Foreclosure? An Introduction.)
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:
In some cases, the servicer also runs an NPV test. (For a walk through of the loan modification process, see Getting Your Mortgage Loan Modified.)
After evaluating the borrower’s financial circumstances, the servicer then sometimes (depending on investor guidelines) makes a comparison between:
This evaluation is called an NPV test.
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 servicer will also calculate the NPV of the cash flow expected from a modification. The servicer will review certain information, including:
The servicer compares the NPV for a foreclosure versus modification; whichever is higher is the option the servicer will take. If a loan modification makes sense from an NPV perspective, the lender will make sure 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.
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.
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). 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.
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. (To learn when you should consider hiring a lawyer to help you with a modification, see Nolo’s article Should I Hire a Lawyer to Help With My Mortgage Modification?)
If you need help applying for a modification with your servicer, a HUD-approved housing counselor can help you at no cost.