A net present value (NPV) is a test used by lenders when determining an approval for a loan modification. NPV helps lenders determine if a loan modification is a profitable decision or not.
Options
Lenders use NPV to decide if by modifying the loan, which reduces payments to the borrower, is a better decision in the long run than not modifying it and having the risk of the borrower going through a foreclosure on the house. NPV helps lenders decide the likelihood of the borrower foreclosing using both options.
Considerations
When lenders calculate the NPV, they take many factors into consideration. They analyze how likely the borrower is able to catch up on past-due payments without a modification. They investigate the home's current value, the home's value in one year and how many months on average before the homeowner may default. Lenders also analyze how much the home would likely sell for if it forecloses.
Details
When the NPV is calculated, the lender is basically comparing the loan if it is not modified against if it is modified. The lender takes the expected cash flows through both situations and bases the modification decision primarily on this factor.
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