US97 - Require High-NPV Principal Reduction Modifications
The Home Affordable Modification Program (HAMP) has been successful in implementing major reform in the mortgage servicing industry. The program requires mortgage servicers to offer modifications rather than foreclose if the net present value (NPV) of the modified mortgage is greater than expected proceeds from foreclosure. This is basic cost-benefit analysis that requires mortgage servicers to act on win-win opportunities (when there is benefit to public welfare and benefit to the mortgage investor).
Servicers are also required to calculate an NPV for a principal reduction alternative (PRA) version of the modification, but they are not required to offer it even if the NPV is higher than the alternatives (non-PRA mod or foreclosure). Servicers should be required to offer principal reduction modifications if they have the highest NPV. This is the most beneficial outcome for both the homeowner and the investor. This would add an average of $70k in principal reduction to many modifications, and it would require modifications (i.e., stop foreclosure) for many thousands of homeowners for whom the PRA NPV > foreclosure NPV > non-PRA NPV.
Principal reduction should be analyzed from the perspective of what will earn the most money in the long run. I believe that this will benefit some homeowners because, as the saying goes, you can’t get blood from a rock, and often principal reduction will create a longer stream of mortgage payments, more money in total for investors, and prevent foreclosed homes from further dragging down home values.
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