How Bank of America's principal reduction plan will work

Bank of America forgives some underwater homeownersIf you have a loan directly from Bank of America or Countrywide and are 60 days or more late, you may qualify for its new "earned principal forgiveness." Also about 95% of the loans that Bank of America services for private investors in which the investor has delegated authority to the bank may qualify. The types of loans that may qualify include pay option ARMs, prime two-year hybrid mortgages and subprime loans initially offered by Countrywide. Fannie Mae and Freddie Mac loans will not be eligible.

But don't rush to make a call to Bank of America today. The new program won't be available until May and Bank of America will be doing the outreach to you if you qualify. Jack Schakett, a credit loss mitigation strategies executive for the bank, said in a press conference today there were 1.5 million borrowers 60 days or more behind on their loans, but not all these borrowers will qualify. Right now the bank estimates about 45,000 customers will ultimately qualify for this program and about $3 billion dollars of principal will be reduced, provided all the customers accept and complete the program.

"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 – specifically subprime loans, Pay-Option ARMs and prime two-year hybrid ARMs that are 60 days or more delinquent with a principal balance of 120% or more," said Barbara Desoer, president of Bank of America Home Loans during a press conference today.

This "earned principal forgiveness" program will be offered as part of Bank of America's National Homeownership Retention Program, which is available in 44 states and the District of Columbia. The program will be incorporated with the bank's federal government's Home Affordable Modification Program (HAMP), and the bank believes it can serve as a model for other modification programs at Bank of America and at other banks.

Here's how it will work:
  1. If you have a pay option ARM the bank will first look at your negative amortization account. With these loans borrowers were able to defer interest payments and these payments are held in negative amortization accounts. As part of the HAMP modification, the bank will eliminate this feature and forgive all or part of the negative amortization to reduce principal to as low as 95% loan to value (LTV).
  2. Also, pay option ARMs will be recast to eliminate the negative amortization and converted to fully amortizing loans.
  3. Next if the principal balance of the loan is greater than 120% LTV the bank will consider a set-aside of up to 30% of the principal as an "interest-free forbearance of principal." The amount set aside interest-free will be eligible for possible forgiveness.
  4. In addition to pay option ARMs, some prime two-year hybrids and Countrywide mortgages will be included in this program.
  5. As long as you pay your loan on time during a five year period, it's possible all the interest-free principal that was set aside will be forgiven. Whether or not all is forgiven will depend on the value of your home in the fourth and fifth year.
So let's look at the numbers and how this process will work. Schakett used the example of a home now worth $200,000 but with a mortgage of $250,000. In this scenario $50,000 would be set aside as an "interest-free forbearance of principal." In determining the HAMP payment the bank would use a $200,000 loan-to-value to set the new mortgage payments.

As long as homeowners continue to pay the loan on time over a five-year period, each year one fifth of the "interest-free" principal set aside would be forgiven. So, for example, at the end of the first year $10,000 would be forgiven. This will continue each year as long as the forgiven amount does not reduce the principal below 100% of the current market value.

In years four and five, if the market value has recovered, some of the principal may not be forgiven. For example, suppose in year four the house price has appreciated $20,000 and now the house is worth $220,000, the remaining $20,000 sitting in the "interest-free" account would not be forgiven.

By not allowing homeowners to benefit from a principal reduction below 100% of market value, Desoer said this "also recognizes and addresses the interests of mortgage investors by ensuring that forgiveness is tied to the homeowner's performance, reducing the probability of a future default under the modified terms, and adjusting the total amount to be forgiven in light of any gains in property values that might occur in an economic recovery."

To qualify for this principal forgiveness, homeowners will need to meet all the other qualifications of HAMP. They will need to prove that they have a hardship and cannot afford their current mortgage. Bank of America has found that without forgiving principal on severely underwater mortgages, people will not accept a modification, Desoer explained.

Hopefully Bank of America will find this program more successful and expand it to even more potential homeowners in trouble. Other banks should also take a look at this new innovative program and adopt it.

Lita Epstein has written more than 25 books including The Complete Idiot's Guide to Personal Bankruptcy and The 250 Questions Your Should Ask to Avoid Foreclosure.
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