Calculating the Net Present Value (NPV) of a Foreclosure vs. a Loan Modification

Last Updated Sep 23, 2009 5:53 PM EDT

Now I (sort of) understand why so many homeowners are in loan modification hell.

This Dante's Housing Crisis Inferno has been fanned by the introduction of a simple calculation: the NPV.

What's the NPV? NPV stands for net present value, and it is an accounting calculation that every lender makes about each loan that is reviewed for a possible loan modification. The goal of the NPV is to help a lender calculate whether it is more profitable to do a loan modification or let the home fall into foreclosure.

The lender enters numbers into a complicated formula: the homeowners income, assets, appraised value of the home, etc. Then, the calculation takes into account certain assuptions about how much cash the property would generate for the investor if the home goes into foreclosure versus how much the investor would get if the loan servicer completes a successful loan modification.

Ka-ching! Out pops an answer - whether the homeowner gets a loan modification or not may boil down to whether the investor will get an extra $1,000 to $3,000. If you make too much money, or the lender calculates that the property will not get much in a foreclosure sale, you might get your loan modification. If you don't make enough money and the lender decides they'll get more from a foreclosure sale, your loan modification application will be denied.

But here's the thing - homeowners aren't being told that the NPV calculations are the reason why their loan modification applications are being rejected. They're simply being told "You don't qualify." And, they're left hanging for weeks and even months waiting for that opaque answer.

That makes it extremely difficult and frustrating for homeowners.

At a conference I attended last week, a Treasury official laid out how the NPV calculation is supposed to work. While studies show that investors tend to lose two-thirds of their investments in foreclosures versus 5 to 10 percent in a loan modification, it was clear from his example that some of the assumptions used in loan modification NPV calculations appear to be based in fantasy rather than today's housing crisis reality.

Geoffry Walsh, staff attorney with the National Consumer Law Center and author of a new study called "State and Local Foreclosure Mediation Programs: Can They Save Homes," confirms that some NPV calculations are based on outmoded numbers.

Could this be the missing link? Is this why loan modifications are taking forever to complete?

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    Ilyce R. Glink is an award-winning, nationally-syndicated columnist, best-selling book author and founder of Best Money Moves, an employee benefit program that helps reduce financial stress. She also owns, where readers can find real estate and personal finance resources.