What is Net Present Value, the NPV we hear about so much? And what is NPV analysis?
NPV is what your mortgage is worth to the bank in today’s dollars. In deciding whether to foreclose or allow modification the lender compares the amount of money it will net if it forecloses versus the present value of the income stream it will receive over the years if the lender allows modification. Future payments are reduced to present value. The math is a bit complex, but you could learn how to do it if you set your mind to it.
To make it simple, I will give an extreme example. If your home is worth $300,000 even in this difficult market and you owe only $100,000, then the lender will recover its entire $100,000 if it forecloses. If the lender modifies your loan by lowering the interest rate, it will not recover as much money. People with lots of equity in their home certainly will not get a Making Home Affordable HAMP modification. The rules do not allow it. Maybe they will get an in-house modification, but the lender is not obligated to give one. Generally a lender will give a borrower a forbearance agreement – which actually raises your payments by requiring you to make your regular payment plus a portion of the arrearage until you catch up.
What if your home is worth only $250,000, and you owe $300,000 on your mortgage, then the analysis gets complicated. Off the top the lender is going to lose $50,000 plus the cost of foreclosure plus possible costs for repairing the property. If the lender gives you the 2% rate for five years, followed by 3% for a year, 4% for a year, and the Freddie rate for the balance of the loan, the lender is going to lose interest it might earn by lending out the money to someone else. The two different losses must be compared.
Note: Your lender does not consider the balance owing on your second mortgage in doing its NPV analysis.
The lender must also factor in how likely you are to default over again. If your expenses are very high, if your income is low, if you have a poor record for paying your debts, those are factors which weigh in favor of a foreclosure.
In Washington lenders are required to perform an NPV analysis under the new law passed July 22, 2011. A borrower who has been denied modification and is facing foreclosure can stop the foreclosure by demanding mediation. If the lender is going to lose less by modifying than by foreclosing, then the lender cannot foreclose. See the bill which enacted this law. The steps involved in mediation are set forth in RCW 6.24.163.
The cost of mediation is $200. The application for mediation must be filed through an attorney or a licensed non-profit foreclosure mediation group.
See this example of an NPV analysis done by Wachovia, which now is owned by Wells Fargo. This borrower was turned down because his debt load was too high and his income was too low.
The property is further underwater now than when he was previously considered. Further, the Borrower has been through Chapter 7 bankruptcy and has shed a lot of debt. Also there is more income in the family because we are counting the income of the Borrower’s children – which is allowed.
We are confident that we can succeed in getting a modification for this client.