Foreclosure Freedom Network Show of 10/22/2009: What is the Net Present Value (NPV) Test and how does this relate to my Loan Modification?

Hello and welcome to the Foreclosure Freedom Network Show!  This is Connie Saunders.  I’ve been in the mortgage industry for 20 years and am a licensed California Realtor.  Today I thought I’d take some time to go over some extremely important and HIDDEN VITAL information about loan modifications.

First of all, no matter who you are if you have a home loan in trouble you can pick up a phone and call the HOPE line for some immediate assistance and counsel.  If that doesn’t work for you, you can request the name of a local housing counselor.  For these services, and they are just terrific if and when they work, you pay nothing.  I would highly recommend anyone in trouble on their home loan to go to such an agency first.  You may be pleasantly surprised that it was just an easy one-hour conversation and voila, you have a loan modification that is affordable.

The HOPE line’s number is 1(888) 995-HOPE.  They are even open after hours.

There will be a certain number of you who may not get success with this, however, and there are other options.  All of you are invited to my Blog where there are over 20 Radio Shows, some You Tube Videos, lots of forms and documents and explanations of the complex situations we have and my view of the solutions that are out there for you.

This week I was working with a couple on a loan modification and the lender after five months still asserted it needed to wait until at least October 22nd before it could respond to the appeal submitted to get this couple a loan modification.  The key reason for the appeal was that they were disapproved for a loan yet the ‘Net Present Value’ was indeed higher to keep these folks in their home than to foreclose yet this lender wouldn’t consider lowering the interest to 2% and stretching the term out to 40 years and when pressed could/would only say “No” to a loan modification.

I know the subject of accounting and loan servicing is remote from the vocabulary of many of my listeners.  Keep in mind that I do have the full text of this show on my Blog and whether you are working with an Attorney, Realtor, Accountant, HOPE line consultant or other profit or non profit negotiator on your behalf you can direct them to this site and to this show for some incredibly key tips on understanding what’s up and what’s down in today’s Crisis situation, what this means generally speaking and key terms.  Knowledge is Power and the more you know the more you can control your own fate with regards to the more difficult loan modification scenario.

I advised my client, who was wary of the delay, to try submitting the data to the HOPE line to see what they advised.  It really is the best way to get a second professional opinion on what way to go and I’m all for that.  HOPE’s online service is much faster than NACA (which requires a course or online application and acceptance along with a somewhat elaborate contract to be signed), so I would personally recommend HOPE consultants.  Also there are HUD Certified local counselors in your area, where you can bring all of your documents and have a face to face meeting with them and have them be an advocate for you, if they run the numbers and determine you should qualify.

Unfortunately at the end of my Clients attempt with HOPE they told them they were completely unqualified and to give up and advised them to Short Sell the home.  When I evaluated it later it turned out that it was simply some omitted actions that would easily remedy the too high debt side of their financial forms and the ever so slightly (8 dollar) too low income side of them.   I definitely don’t propose to know all the lender equations, but I can tell you it is rare that the lender or a HOPE consultant will go into any detail to speak of when rejecting a loan modification for someone.  So do demand it.  Listen to the rest of the show where I’ll go over this in more detail.

Most often when the calculations all seem to add up to your being offered a loan modification and you are rejected it’s because you have what’s called a non-GSE loan (not Government Sponsored Enterprise like Fannie and Freddie as the underlying investor.)  In addition to this there are many odd scenarios that can interfere with lender cooperation on offering you a modification.  Net Present Value is a standard financial investment term but can be wildly altered, so it’s good to get this clarified.

What Does this term Net Present Value Mean?  According to Investopedia:

The difference between the present value of cash inflows and the present value of cash outflows. NPV is used to analyze the profitability of an investment or project.

NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield.   When calculating projected inflow of capital on a loan ten years into the future it must also project the loss of income from not getting interest in a straight savings product such as a Treasury Bill, so when doing the Net Present Value test future income is projected as worth less than the actual projected dollars in hand.

NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also be negative.  This is called the Net Present Value Rule and logically should be followed, though often this equation is hindered by the GIGO factor.  (Garbage In = Garbage Out) and hindered by the underlying investors level of solvency and overall future plans for capital.

A key factor on this one and on all loan modifications is not who the loan servicer is as much as who the underlying investor is.  Each underlying investors (and some lenders have thousands of these) have different requirements.  These requirements can get rather complex, because they have or could have been modified by various regulations imposed by State or US government over the past couple of years. An example of underlying investor in this case is Fannie Mae or Deutch, who both don’t appear on US Mortgage documents usually yet it was their moneys that funded the loan and it is they, indeed, and their rules who continue to control the ‘rules’ in play on this loan.  Let’s say we have an apparent lender of B of A and underlying investor of Fannie Mae.  In that case you would be in luck because Fannie Mae rules are very much more pro on keeping people in their home than that of a foreign owned Bank like Deutch.  The average Joe would only know their loan was with B of A.

Because of this some distressed underlying investors are prone to purposefully alter the allowance of the standard Net Present Value calculations and rather than expressing this as a standard calculation with a positive result meaning they should modify the loan, they simply opt to say their only loss mitigation option is Short Sale or Foreclosure.   This can tie up your loan servicers hands without some external pressure.

In California, Civil Code 2923.6 REQUIRES a lender to do a Net Present Value test and abide by the positive outcome on the cash flow of retaining an asset with a loan modification and comparing that to proceeding to Foreclosure - not Short Sales or other but Foreclosure, and this is dictated again by Civil Code.  Lenders today use a standard model of Net Present Value evaluation.  In fact there is a new program being trained up for which must be used by all beginning November 1st, and this new version promises to have more workout possibilities and save more home loans.  So if at first you don’t succeed: try, try again.  This computer program is highly complex and is different for GSE’s and non-GSE’s based on the HAMP guidelines and calculates this after inputting several pieces of information.

When determining whether a borrower is eligible under the Home Affordable Modification Program (HAMP), the first fork in the road is whether the underlying investor is a GSE or Non GSE.  Major rule changes exist if it is a non-GSE as these loans are ‘not in the club’ so to speak but may be given certain ‘guest’ privileges depending on who they are..

Then the loan must be evaluated using a standardized net present value (NPV) test that compares the expected economic outcome of the loan with and without the proposed modification. Servicers are instructed to consult the specific investor’s guidelines.  With thousands of investors including such obscure investors or representatives as Wells Fargo Trustee for SBA Pool 123 who isn’t a real person but as a Trust has been made into a legal entity.

Now I want to add here and this is important, that these underlying investors must follow State statutes and laws.  They cannot ignore them but they do, so it is up to you or your advocate /agent to bring this to their attention, if your loan modification is denied.

If a borrower has poor governance, meaning their forms are sloppy and show values that change according to whim or fancy, the lender can and usually does ignore the net present value rule. But on the other hand, there are occasions where you will find a lender the lender/servicer who will take on a negative ‘Net Present Value’ loan modification, just to prove that they do it, creating an illusion of cooperation. Bottom line is if you’re a sloppy administrator of your financial affairs and flunk this test, get someone to help put your accounts in better order could mean the world of difference.

This is your primary residence, your home, if you are presented with a ‘not qualified’ you owe it to yourself to get a second professional opinion - or third!  I like to run it through the ‘if it goes to court’ test (which is one of my own creation) where I asses every civil code violation the lender has done and let the lender know in writing my findings, giving them 14 days to call me.  There is no reason why any home-owner can’t do this.  Two key Civil Codes for this in California is 2923.5 and 6.

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Here are some more calculations that the lenders do:  (More data will be put on the website into the link for this Radio Show on the Blog.)

1. Obtain a (less than 90 day old) package from the borrower and co-borrowers including financial information, credit score, current gross income, debt levels (mortgage related, credit cards, auto and other non secured debt).
2. Ensure this data is accurate.  Be very certain this data in input accurately, so do ask your servicer if they can provide you with a copy of the data they actually input for you into their system calculator.  They are required to keep all of this anyway so shouldn’t have any problem sending you a copy of this so that you can side check it.  This is the GIGO test (Garbage in = Garbage out).
3. If there are two borrowers they enter the credit scores for both the borrower and co-borrower.
4. Enter in the current value of the property securing the loan.  This is key to determining Current Property Value or CPV.  They can use the GSE’s automated valuation model or AVM or could use another, such as Broker Price Opinion or appraisal.  When talking with them find out what model they are using - should this result in a negative score all the factors used will need to be evaluated and appraisal would be a key value.  The valuation cannot be more than 90 days old.
5. If Mortgage Insurance is being paid on this property the evaluator is to assume this payout of the partial claim will be zero.  This is a behind the scenes requirement, however if you do have Mortgage Insurance and this Net Present Value test shows a negative result than you can request what’s called a “Second Look”, which is rather involved, done by a different agency and will hold up your decision for a few weeks possibly but could be worth it where it would reverse this decision.
6. If you have a non GSE and the Net present Value comes back negative, the mortgage insurer after review can propose a partial claim payment and when this is entered in to the NPV calculations it could change your loan to a positive value.

Here are some industry terms that can help you to better understand what this Net Present Value test is aiming for.

The Net Present Value test is a Discounted Cash Flow analysis of your loan projected into the future with a modification compared to into the future with a foreclosure.  Average foreclosures in California can cost 50 - 60,000, and this cost would be discounted on the foreclosure side of the equation.  Additionally on the foreclosure side the Current market value of the property would prevail and certainly not a nickel more.

What Does Discounted Cash Flow - DCF Mean?
A valuation method used to estimate the attractiveness of an investment opportunity. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment.

Investopedia explains Discounted Cash Flow - DCF
There are many variations when it comes to what you can use for your cash flows and discount rate in a DCF analysis. Despite the complexity of the calculations involved, the purpose of DCF analysis is just to estimate the money you’d receive from an investment and to adjust for the time value of money.

Discounted cash flow models are powerful, but they do have shortcomings. DCF is merely a mechanical valuation tool, which makes it subject to the axiom “garbage in, garbage out”. Small changes in inputs can result in large changes in the value of a company. Instead of trying to project the cash flows to infinity, terminal value techniques are often used. A simple annuity (or basic and simple calculation of payments received) is used to estimate the terminal value (which means the present value at a future point) past 10 years, for example. This is done because it is harder to come to a realistic estimate of the cash flows as time goes on.

What Does Time Value of Money Mean?  Investopedia says:

Provided money can earn interest, any amount of money is worth more the sooner it is received.

Also referred to as “present discounted value”.

For example, assuming a 5% interest rate, $100 invested today will be worth $105 in one year ($100 multiplied by 1.05).  Conversely, $100 received one year from now is only worth $95.24 today ($100 divided by 1.05), assuming a 5% interest rate.

Most people who are not lenders have no idea of what Net Present Value means, yet for all of you this is absolutely key to whether you will get a loan modification and whether you have cause to complain if the lender doesn’t give you a loan modification.  In fact this single factor has become the industry standard for determining if someone is qualified for a loan modification.

With regards to the Home Affordable Modification Plan, If the result of the NPV test is positive, this means that the NPV of the proposed modified loan is greater than the NPV of the unmodified loan. A negative outcome means the NPV of the proposed modified loan is less than the NPV of the unmodified loan.

If when evaluating this the Mark-to-Market LTV ratio falls below 100% the borrower is not eligible for a modification under this Program and should be considered for other loss mitigation options.  This is what the text book says but this is not entirely true.  It’s possible that the equations can be run again with less debt or more income and the outcome will completely change.

To get less debt can be as simple as calling ‘Credit Advisors’, a non profit credit card advisor foundation that has been in business dozens of years and for a nominal fee can get ones credit card interest down to a LOW percentage.  So lenders, and all others listening to this show, please listen up.  You do have to have a person in place who can counsel and advise on this kind of option as well.  So many of the lender troops are geared up on rote procedure without having the knowledge base or authority level to suggest all the options that there really are.

Again, if you are disappointed with your loan modification results, use an expert and try to get one who doesn’t charge upfront fees, or become your own expert!

If a modification is not pursued when the NPV result is negative, you must consider the borrower for other loss mitigation options, including an alternative modification
program, deed-in-lieu, or pre-foreclosure sale.

For non-GSE mortgages serviced on behalf of a third-party investor where the NPV result is negative, you may perform the modification only if you have the express permission of
the investor.