How Bank of America’s Mortgage Write-Down Program Works :

Bank of America is making a new effort to modify mortgages by cutting loan balances.

Under the program, Bank of America will reduce certain loans by up to 30% in order to lower monthly payments for borrowers facing foreclosure. Here’s how it works: ONLY  borrowers who had loans from Countrywide Financial, which Bank of America acquired in mid-2008, will be eligible. And ONLY the riskiest loans will qualify: subprime loans, “option adjustable-rate” mortgages that have low initial monthly payments but that can adjust sharply higher, and certain prime loans that have a fixed interest rate for the first two years before starting to adjust annually.

The program is also limited to customers who have missed at least two consecutive payments, who can demonstrate that a financial hardship prevents them from making payments at the current level, and whose loan balance is at least 120% of the estimated home value.

Bank of America will go through its loan book to see which loans might qualify for reductions (while checking property values to see which ones are far enough under water), and then the bank will contact the borrowrs.

Bank of America says that around 45,000 borrowers could see their loan balances reduced with an average reduction of more than $62,000.

The bank’s approach has an interesting design feature in an attempt to prevent homeowners who are still paying their loans from defaulting and becoming eligible for the program. Loan balances aren’t reduced in one clean strike. Instead, the bank  is offering what’s called “earned forgiveness.”

The program works like this: for a borrower who owes $300,000 on a home worth $200,000, the bank would reduce up to $100,000 in principal and place it in an interest-free account. For each of five years, the bank would forgive another $20,000 as long as the borrower continued to make payments and until the borrower was returned to a 100% loan-to-value ratio. If home prices have recovered by the fourth or fifth year to meet the amount owed, Bank of America would stop forgiving money in the interest-free account, which would have to be paid off when the home is sold or the loan is refinanced.

What about SECOND MORTGAGES? To be sure, there are drawbacks.  Bank of America said it will modify first mortgages that have seconds behind them only when Bank of America owns the first mortgage AS WELL.  The government’s modification program, Home Affordable Modification Program, has faced challenges because borrowers haven’t been able to document their incomes, and those requirements don’t go away in this effort.

This is aimed towards helping those in deep financial difficulty so it will be interesting to see how it works.