Bank of America to Cut Principal on Underwater Mortgages

Bank of America (BAC) is giving the green light to a program designed to cut the principal on severely underwater adjustable-rate mortgages (ARMs) held by some of its borrowers, rather than attempting to address the issue with mere interest rate reductions, the company announced Wednesday.

With its program, BofA will be one of the first lenders to address the mortgage meltdown via a principal reduction plan. The move will likely quell critics who say BofA and other big lenders aren't moving fast enough or cutting deep enough to address the country's massive foreclosure problem, which the Treasury Department sought to tackle through its Home Affordable Modification Program.

"It looks like a pretty good program," says Celia Chen, senior director of Moody's Economy.com. "They will reduce the principal up to 30%, and that could potentially be a big reduction."

Although the program appears well-structured, Chen notes that it will address only an estimated 45,000 customers -- barely more than 1% of the 4 million borrowers whom Moody's estimates are in foreclosure proceedings or 90-days delinquent on their mortgages.

"Targeting the Right Kind of People"

Under its Earned Principal Forgiveness program, which is scheduled to launch in May, BofA will target borrowers who received a subprime loan with a minuscule down payment and a pay-option ARM, the combination of which can result in borrowers owing more as deferred interest payments get added to the principal. Candidates for the program will also need to be at least 60 days delinquent on their mortgages and hold a loan on a property that was valued 20% higher than the current market value.

"They are targeting the right kinds of people for this program," Chen says, noting that these borrowers tend to have little skin in the game in terms of equity lost and would be more apt to let their homes go into foreclosure if they found themselves having difficulty making their payments.

Those who qualify for the program would be allowed to decrease the principal they owe by up to 30% over a five-year period, in an effort to adjust the loan to a level where it reflects current property values. The bank will also offer an interest-free forbearance on principal, meaning borrowers won't get hit with unpaid interest charges being tacked onto their principal.

"The centerpiece of these enhancements is a program of earned principal forgiveness that addresses severely underwater mortgages with some of the highest rates of delinquency," said Barbara Desoer, president of Bank of America Home Loans, in a statement.