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Mortgage Modifications Part 5: The NPV Test — Math or Scam?

So, after you have figured out if you might qualify to apply for Home Affordable Modification Program (HAMP) modification (see Part 3 of this series), and after you figure out if you loan payment can be modified down to 31% of gross monthly income (see Part 4 of this series) and after you have assembled the documents that will prove your income and ability to pay the 31% payment, the bank or servicer — as the case may be — will do its own evaluation to figure out whether the loan will bring in more money if it is modified vs. foreclosed.

The Method for doing this is called the Net Present Value (NPV) test [PDF]. Let me start off be saying that on a 30- or 40-year loan, there will almost always be a much greater total return by allowing payment over that long period of time; unless you are anticipating decades of runaway inflation.

The following are the inputs to the NPV tests. Some of them, the borrower can already know or find out; some are being treated like the super secret codes in the president’s nuclear football.

1)      The value of the home relative to the amount of the loan. Most homeowners know the outstanding principle amount of their loan and can find out the current value of their house by having an appraisal done. Most of us, these days, have a pretty good idea of our home’s current value.

2)      The likelihood of foreclosure. You know if you are in default, about to go into default, or are already in foreclosure proceedings. This one is easy to figure out.

3)      Home price trends. You would think you know this one. However, anecdotal evidence suggests that banks/servicers have been using incorrect trend data in doing their evaluations. Therefore, it becomes important to know this information and have it available in a form that would be admissible in court. The data must be current, at least less than 90 days old, preferably less than 30 days old.

4)      The cost of foreclosure vs. the cost of modification. Unfortunately, this is a number that is supplied solely by the bank/servicer and they have not been too forthcoming on showing how they reach that figure, making it impossible to know if the inputs into that figure were made in good faith or even to simply check the math. Cost of foreclosure includes:

a)      Legal expenses

b)      Lost interest during the time needed to complete the foreclosure action

c)       Property maintenance costs

d)      Expenses involved in reselling the property

The cost of modification includes:

a)      The lower monthly payment from the borrower

b)      The likelihood that the borrower will re-default even after the loan is modified

c)       The financial incentives provided by the government (the servicers and lenders get cash payments for modifying)

d)      The likelihood that the loan will be paid off before its term expires.

5)      The default rates and the discount rates. These are also supplied by the banks/servicers. The default rate is the probability that the loan will default or re-default. The discount rates are the “present value” of the cash flows if the loan defaults and the present value of the cash flows if the loan is modified. Present value discounting has been around for a long time and there are even cute little widgets on the internet that can do the math for you. However, present value calculations are often tweaked or weighted to reflect conditions in a particular industry or geographical location. So, determining the correct discount rate to apply is important. The banks and lenders have been guarding the default rate calculations and the discount rate calculations very closely. So, the public does not know if they are being supplied and applied in good faith, or even correctly. We can’t check the math.

This business of not being able to check the math becomes critical. You see under HAMP if the NPV test is positive—that is, if the total value under modification is greater than the total value under foreclosure – the loan MUST be modified. No discretion! Even if the NPV test is negative, the loan might still be modified, but it is totally at the discretion of the investor.

Common sense tells you that if the house is underwater, and no principle is being forgiven, that just about every NVP test should come out positive, right? Yet, of the reported 1.3 borrowers who were offered modifications, only 116,000 have actually attained a permanent modification. And these are the January 2010 figures [PDF] AFTER the big push by Treasury [PDF] in late November 2009, to flog the servicers into getting more permanent modifications done. Before that, the conversion rate was much lower.


WASHINGTON – The U.S. Department of the Treasury and Department of Housing and Urban Development (HUD) today kick off a nationwide campaign to help borrowers who are currently in the trial phase of their modified mortgages under the Obama Administration’s Home Affordable Modification Program (HAMP) convert to permanent modifications

A bright spot on the horizon: The bankruptcy courts in the Southern and Eastern District of New York have a “Loss Mitigation Program” (see Part 1 of this series) and the NYS Supreme Court has created specialized “parts” to hear only foreclosure cases. Both have mandatory good faith modification negotiations as part of their procedure.

It has been pointed out, that the courts get to define what constitutes “good faith” in these modification negotiations. So, if the servicer says that the loan does not qualify for modification, the court could require that the servicer show all the inputs it used in the NPV test and as well as all of the math. This allows the consumer to challenge the validity of the inputs (assumptions, like the current value of the house—get your own appraisal done) and to point out any math errors.

I know this all sounds daunting, but there are mortgage counseling services out there and housing advocates who can help you “do the math”. Most are free. We’re talking about saving your home; it’s worth learning a new skill, isn’t it?

[Earlier posts in this series and related links at Kouril’s Foreclosure Fraud Resources]

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Cynthia Kouril

Cynthia Kouril

Cynthia Kouril is a former Special Assistant United States Attorney in the Southern District of New York under several different U.S. Attorneys, former counsel to the Inspector General for the N.Y.C. Department of Environmental Protection where she investigated threats to the New York City water supply and other environmental crimes, as well as public corruption and fraud against the government, former Examining Attorney at the N.Y.C. Department of Investigation and former Capital Construction Counsel at New York City Parks and Recreation.
She is now in private practice with a colleague whom she met while at the USA Attorney's Office. Ms. Kouril is a member of the Steering Committee, National Committeewoman and Regional Coordinator for the New York Democratic Lawyers Council, a member of the Program Committee of the Federal Bar Council and a member of the Election Law Committee at the Association of the Bar of the City of New York. She is active in several other Bar Associations.
Most important of all, she is a soccer mom.