The "Loan Xperts" Blog

For hundreds of thousands of homeowners who are behind on their mortgage payments and underwater on their mortgages, it's a question that comes up often: Is there any chance that our lender would consider accepting a lower amount then we owe, and not just reduce our monthly payments?

While the Fed’s HAMP program does make allowance for principal reductions through their loan modification program, the answer to this question has been a resounding NO. Many lenders have been willing to reduce interest rates and even write off some fees, but for the most part they have been dead-set against forgiving any portion of the principal balance owed.

However, with a recent announcement by Bank of America the outlook for principal reductions may be on the verge of significant change, as they have unveiled the mortgage industry's first large-scale principal forgiveness program. It is estimated that as many as 45,000 underwater borrowers may receive as much as $3 billion in debt write-offs.

Additionally, the Treasury Department has confirmed that the administration is examining debt forgiveness options as potential add-on features to its existing mortgage-modification programs. It is expected that these program changes will be announced within the next few weeks and, if adopted by the industry, could ultimately affect loan modifications offered by substantial numbers of banks and mortgage companies.

While Bank of America's program targets borrowers with loan-to-value [LTV] ratios in excess of 120 percent or more, there is no limit on how far underwater borrowers can be, but the program caps the principal reduction on any primary residence to 30%. Initially the bank will look to a phased-in principal forgiveness as the first step in keeping underwater borrowers out of foreclosure, rather than giving consideration to a rate reduction first.

Bank of America Home Loans President, Barbara Desoer said that this program attempts to address the problems of the most "severely underwater mortgages with some of the highest rates of delinquency," and it could "become an industry model for principal reductions" on a far broader scale.

Targeted initially will be three mortgage products that were promoted and taken advantage of by borrowers, many of them investors during the housing boom: subprime loans; option arm loans (Negatively amortizing loans), and 2-1 “Buy-Downs” that offered teaser interest rates for the first two years. For certain option arm borrowers who are underwater in part because of the negative-amortization features of the loan itself, the bank will forgive the negative-amortization amount down to a 95 percent LTV level.

Wells Fargo has also quietly moved to selectively offering principal reductions for some of their borrowers with underwater option arm loans. With additional pressure coming from the Obama administration to stem the foreclosure crisis, we could expect to see principal forgiveness programs offered to many more over-leveraged homeowners who are drowning in mortgage debt and at risk of losing their homes top foreclosure.