By Renae Merle and Dina Elboghdady
Washington Post Staff Writer
Wednesday, March 24, 2010; 8:17 PM
Bank of America, the nation's largest mortgage lender, announced a program Wednesday that it said could reduce the mortgage balances of about 45,000 homeowners nationwide who owe significantly more than their homes are worth.
The initiative, which starts in May, thrusts Bank of America into a debate about how to address the millions of homeowners whose mortgages exceed the value of their homes. The Obama administration has come under increasing pressure to address the problem, which has complicated industry and government efforts to prevent foreclosures.
Lenders have traditionally resisted reducing borrowers' loan balances, arguing that doing so would encourage homeowners to miss mortgage payments to qualify. But as foreclosure prevention efforts have struggled, the industry has started to reconsider. Last year, Wells Fargo reduced $2.6 billion worth of principal for its borrowers.
Bank of America is hoping that by reducing principal balances, it will give borrowers an incentive to keep up with payments and perhaps create an industry model. The program expands a settlement agreement that the bank reached with several state attorneys general in 2008 and settles a Massachusetts investigation into the lending practices of Countrywide Financial, which Bank of America acquired two years ago.
But the bank's initiative is limited in scope. Borrowers must have missed at least two mortgage payments and be severely underwater to qualify, owing 20 percent more than their homes are worth. It is also limited to borrowers with certain types of risky loans, including subprime mortgages or other loans with a two-year adjustable rate.
For homeowners who qualify, Bank of America said it would consider reducing their principal balances by up to 30 percent before reducing their interest rates -- the traditional first step in mortgage-relief programs, including the federal foreclosure prevention program called Making Home Affordable.
The reduced amount would be put into another account and forgiven gradually over five years if the borrowers keep up with their payments. If borrowers fall behind, they could face a balloon payment at the end of their mortgage to make up the difference.
The Bank of America program also includes a chance at forgiveness of principal for borrowers with "option" adjustable-rate mortgages, even if they have not missed a payment. These loans allow borrowers to choose how much to pay each month, and many borrowers pay less than the amount of interest due. The unpaid interest is tacked on to the balance. These loans tend to be concentrated in places where home prices soared and then plunged precipitously, leaving many homeowners significantly underwater.
Through its effort, Bank of America expects to forgive about $3 billion in principal on loans. Economists consider underwater borrowers among the most vulnerable because they cannot sell their houses or refinance if they experience a financial setback, increasing their risk of foreclosure. First American CoreLogic has estimated that more than 11.3 million homeowners are underwater on their mortgages.
"We're thrilled that principal reductions will be part of the loan modification mix," said Julia Gordon, senior policy counsel at the Center for Responsible Lending. Although reducing the loan's principal is allowed under the Making Home Affordable program, it is not required and few lenders do it, even though it is key to a sustainable loan modification, Gordon said.
Under the government program, borrowers can receive up to $5,000 to decrease their loan balances if they keep up with their payments.
The effort, however, has resulted in fewer than 200,000 permanent loan modifications through last month, even though the government estimated that it could help up to 4 million borrowers before the program's expiration in 2012, Gene Dodaro, acting comptroller general at the Government Accountability Office, is expected to tell a House panel on Thursday. Only 32 percent of loans that have been in trial modifications for at least three months have been converted to permanent modifications, he said.
The Treasury Department, which oversees the federal program, has not set benchmarks to measure the performance of lenders involved in the program or finalized penalties for those that do not comply with its guidelines, Dodaro said. The GAO had previously concluded that the government's projections about how many borrowers it could help might be overly optimistic, but Treasury has yet to update the projections as GAO recommended, he said.
The GAO also cited inconsistencies in the way lenders treat borrowers. For instance, 10 of the lenders contacted by GAO had seven different sets of criteria for determining whether borrowers who are less than 60 days late qualified for the program.
John Taylor, a housing advocate and chief executive of the National Community Reinvestment Coalition, plans to tell the same House panel that a survey of 29 housing counselors affiliated with his group found that white borrowers who qualify for the federal program are almost 50 percent more likely to receive a modification than eligible African American borrowers.
Treasury officials have said they were considering ways to improve the program and proposals to address negative equity, but have not given a timeline for announcing a plan. They also challenged a government watchdog's interpretations of their original projections, arguing that they only intended to offer help to 4 million borrowers, not necessarily guarantee a modification of each of their loans.
Given the shortcomings of the federal program, more than two dozen House members sent a letter on Wednesday to Treasury Secretary Timothy F. Geithner urging him to consider creating a new federal entity modeled on the Home Owners' Loan Corporation, a New Deal agency created by President Franklin D. Roosevelt to refinance homes and prevent foreclosures.
This entity could be launched quickly and paid for by available bailout funds with "little or no long term cost to the taxpayer," the letter stated.