Bank of America (BofA) will forgive up to 30 percent of the balance owed on certain at-risk mortgages as part of its loan modification efforts to assist homeowners in avoiding foreclosure, the bank has announced.

The program is expected to provide mortgage relief to up to 45,000 borrowers who obtained certain types of home loans through defunct mortgage lender Countrywide, which BofA acquired in 2008. The bank said it expects to write down a total of $3 billion in principal, which works out to an average reduction of nearly $67,000 per borrower.

For qualifying borrowers, BofA said it will look to principal reduction as a first option in seeking to bring a borrower's monthly mortgage payments down to the Home Affordable Modification Program (HAMP) target of 31 percent of monthly income. This is a major change from the usual industry practice, which is to reduce the interest rate in order to reach that target.

The program will be available to former Countrywide borrowers with certain types of subprime, pay-option and two-year hybrid adjustable rate mortgages (ARMs). To qualify, borrowers must be at least 60 days delinquent on their mortgage and have a mortgage balance of at least 120 percent of their current home value. Borrowers must also meet basic qualifications for HAMP, the federal government's loan modification program.

Borrowers who qualify will be eligible for what BofA calls earned principal forgiveness. The bank will forbear up to 30 percent of the loan balance, interest free. If the borrower stays current on their mortgage payments for five years, the forborne principal will be gradually forgiven in equal installments each year.

Principal reduction will be limited to bringing the balance down to no less than 100 percent loan-to-value, so borrowers could see some of the forborne principal restored if their property increases in value during those five years.

The new program is part of an agreement BofA reached with the attorneys general of Massachusetts and several other states over Countrywide's lending practices prior to its acquisition by BofA. The types of former Countrywide mortgages to be modified are generally ARMS in which borrowers are subject to major increases in their mortgage payments once the terms of the loans reset.

Many consumer advocates have been pressing for mortgage servicers to make principal reduction a key part of loan modification efforts, noting that underwater homeowners are among those at highest risk for defaulting on their mortgages.

From a lender's point of view, reducing principal sometimes makes sense when a property declines in value if it enables the mortgage to keep producing revenue while writing off losses that have already occurred due to falling property values.

BofA, which is the largest U.S. bank and #1 mortgage servicer, is reviewing its files to identify eligible customers and says it will contact those who qualify for the new program.

Published on January 2, 2009