As Pressure Mounts, Bank of America Plans Principal Reductions for Underwater Homeowners

This morning, Reuters has reported that Bank of America has announced a program that will offer what the bank is calling an “earned principal forgiveness” of up to 30 percent for homeowners owing more than 120 percent of the value of their homes.

Bank of America says the plan will be available to homeowners nationwide beginning in May of this year. It is certainly the first program of its kind to be announced by such a large financial institution in the sense that it takes a “systematic approach to reducing mortgage principal in an effort to tackle the thorny issue of preventing foreclosures when home values drop well below the amount owed”.

Here’s how the program will work, according to the bank:

Forgiveness of principal will be offered in two stages for the riskiest loans, including sub-prime loans and loans which offered borrowers multiple options for how much to pay each month. 30-year fixed rate loans will NOT be eligible for the program.
Bank of America will offer qualified homeowners an interest-free forbearance of principal that the homeowner can turn into forgiven principal annually over five years, provided they stay current on their mortgage payments. Over the five-year period, homeowner can bring their loan values back down to 100 percent of the home’s market value.

According to Barbara Desoer, who is the president of Bank of America Home Loans, said the following:

“At the same time earned principal forgiveness helps homeowners, it 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.”

I think what that means in reality is that the bank is finally admitting that property values have fallen, well… for good. No, not forever… but for a long, long time. Sure, they’re still allowing for the possibility of home price appreciation in the next five years, but they’re hedging their bets just in case that doesn’t happen.

You see, that’s what the phrase “re-default risk,” when used in conjunction with a loan modification, is all about. Re-default risk isn’t about a homeowner not being able to pay the modified payment in future years, it’s about the homeowner coming to their senses in future years and walking away from an underwater mortgage.

Of course, it’s worth mentioning that Bank of America’s new principal reduction program has not come as a result of the bank simply seeing the light on its own. The pressure has been mounting and undoubtedly will continue to increase. U.S. lawmakers and housing advocates continue to be increasingly vocal about the need for principal write-downs in order to stop the housing carnage on a national scale.

According to Reuters:

“Amid stubbornly high unemployment, homeowners are seen as more likely to simply abandon an unaffordable mortgage when they have no equity or are deep “˜underwater’ on the loan.”

Two days ago, Washington state residents filed a lawsuit against Bank of America for reneging on a promise the mega-bank made to modify mortgages when it took $25 billion in taxpayer bailout money. According to Reuters, the lawsuit alleges that Bank of America has “seriously strung out, delayed and otherwise hindered” loan modifications because it had financial incentives to do so.

And today, Massachusetts Attorney General Martha Coakley obtained a $3 billion settlement from Countrywide/Bank of America that is to provide loan forgiveness to approximately 45,000 Massachusetts homeowners. And that, is they say, is only the tip of the iceberg, in terms of pressures being brought to bear on Bank of America in addition to numerous other financial institutions.

Will it work? Will Bank of America’s best laid plans turn out as planned?

I have no idea, and certainly this is not a bank in which my personal confidence in their competence, shall we say, overflows. In fact, as a good friend of mine said on his first day at work, after accepting a fairly senior level position with Bank of America this past year… in response to my asking how he liked his new job: “There’s no adult supervision and the left hand doesn’t know what the right hand is doing.”

Reuters closed its story announcing the new Bank of America program with the following:

“A $75 billion Obama administration program aimed at helping struggling homeowners avoid foreclosure was sharply criticized on Tuesday by a watchdog, which said the program has been oversold and is likely to be a failure when it wraps up in 2012.”

Likely to be a failure in 2012? Ya’ think? These guys should write for Leno.