By E. Scott Reckard
March 25, 2010
The $3-billion program involves certain adjustable-rate loans issued by Countrywide Financial, the loss-plagued lender that BofA acquired in 2008.
vernment pressure to stem foreclosures, Bank of America Corp. said Wednesday that it would offer to erase as much as $3 billion in principal owed by thousands of severely delinquent borrowers who owe more than their homes are worth.
The bank’s plan is by far the most ambitious and systematic effort by a major lender to help homeowners avoid foreclosures while continuing to make loan payments. Unlike previous initiatives, this one will be geared toward borrowers who are so far underwater that they are unlikely to be helped by a government housing relief plan.
If successful, the plan could become a model for other lenders, experts say, and could also help the still-fragile housing market from being walloped by a new wave of foreclosures.
“I think this is a strong signal to the industry about the importance of principal reduction in a loan modification program,” said Paul Leonard, California director of the Center for Responsible Lending, an advocacy group.
Bank of America’s offer would knock as much as 30% off the principal on about 45,000 adjustable-rate mortgages nationwide. BofA didn’t provide a state-by-state breakdown, but spokesman Rick Simon said the largest block would be in California.
The loans were originally issued by Countrywide Financial Corp., the loss-plagued Calabasas lender that Bank of America acquired in 2008. Countrywide was the nation’s largest mortgage lender, specializing in subprime and other complex loans such as option ARMs, that went bad and helped fuel the nation’s mortgage meltdown.
Bank of America’s new program, adopted to settle a lending-abuse suit by the state of Massachusetts, is in addition to an October 2008 settlement with other state attorneys general that was aimed at reducing payments for Countrywide borrowers by more than $8 billion.
Since introducing programs a year ago to stem the tide of foreclosures, President Obama and other administration officials have been pushing banks to modify increasingly more mortgages. But the criteria for benefiting from those programs were difficult, especially in high-cost areas such as California.
Banks have generally sought to keep borrowers in their homes by adjusting the terms of the loan, such as extending the amount of time it takes to pay off the loan or cutting the interest rate. Lenders have resisted cutting the principal amount, which many housing advocates say is needed because of the inflated prices that homes were fetching during the housing boom.
The Bank of America program stands apart by making principal reduction the first step in the program.
The bank is not initially wiping out part of the loan balances, but instead is exercising what is known as forbearance — setting aside payments of interest on some of the amount owed. It then would allow the borrowers to earn forgiveness gradually on that part of their debt by making regular reduced payments over a five-year period.
The plan is designed to motivate holders of some especially troublesome loans, including option ARMs, or adjustable-rate mortgages for which borrowers had the option of making payments that did not cover the interest costs for five to 10 years.
Many borrowers with option ARMs have been loath to accept modifications because they owed so much more than their homes were worth, said Barbara J. Desoer, president of BofA’s home lending operations.
At the same time, Desoer said, the program protects the interests of the investors who own most of the loans by not granting “windfall forgiveness” of principal but instead requiring the borrowers to earn it through good-faith payments.
“The lenders have been struggling with how to prevent unmerited windfalls to borrowers, and this may be the way,” said Leonard of the Center for Responsible Lending.
The Federal Deposit Insurance Corp. and others have been urging the industry to find a way to allow customers to earn back lost equity, he noted.
Bank of America said it would contact borrowers it deems eligible for the program. To qualify, borrowers must demonstrate a hardship in making current payments, be at least 60 days delinquent on the loans and owe at least 120% of the loan balance. Information on the program was to be posted at www.bankofamerica.com/ homeloanhelp.
Most of the offers, however, will go to holders of option ARMs, whose loan balances have risen during a period when home values have plunged more than 40% in many California areas.
There are an estimated 900,000 option ARMs in existence, according to analysts, and most of the borrowers will be forced to begin making full payments on the loans over the coming two years.
Aside from making principal reduction its centerpiece, the program conforms to the Treasury Department’s loan-modification plan, which has been adopted as the first course of action for troubled mortgages by most loan servicers. The government has pledged to spend as much as $75 billion to reward loan servicers, mortgage bond investors and borrowers who participate.
The aim is to reduce first-mortgage payments to 31% of gross household income. If that can’t be done through principal reduction, Bank of America would employ the other tools of the government plan, reducing the interest rate to as low as 2% and extending the time for payback to as much as 40 years.
Borrowers who agreed to the restructured terms and who made the lower payments as scheduled would be able to gradually convert the principal placed into forbearance into forgiven principal over a five-year period.
For example, a borrower who owed $250,000 might be required to make payments on only $200,000 if that is what the home is currently worth, said Jack Schakett, credit loss mitigation strategies executive at Bank of America Home Loans. Borrowers who stayed current on the modified loan would have 20% of the set-aside $50,000, or $10,000 of their debt, erased each year.
An exception would be made in the fourth and fifth years of the modified loan if home values recover, Schakett said. In those years, the balance could be reduced only to the current amount of the home’s value — a feature the bank designed to placate the investors who own many of the former Countrywide mortgages.
To reach the $3-billion reduction amount, every borrower who receives an offer from BofA would have to accept it and make every payment over the course of five years, Schakett said.
He said the bank believed it would come out ahead on the program because it would be more expensive to let the loans go into foreclosure.
Borrowers with second mortgages or home equity lines of credit will not qualify in certain cases.
Bank of America and other large mortgage servicers have said that the government mortgage modification program as previously applied did not work well with option ARMs because payments already were artificially low and because homeowners were discouraged because they were so far underwater.
So reducing the loan balance — something allowed but not required under the government program — has been seen as the only effective way to modify these loans, and the lenders say they have selectively used their own programs to do so.
Wells Fargo & Co., which inherited more than $100 billion in option ARMs when it took over Wachovia Corp., has said it modified 17% of the option-ARM portfolio with an average principal reduction of 14% by the end of December.
Guy Cecala, chief executive of Inside Mortgage Finance Publications, said Bank of America had taken these efforts a step forward. He called it “a formal recognition by the largest servicer in the country that principal reductions or forgiveness need to be part of any broad foreclosure avoidance strategy.”
“And the idea of offering principal reductions over several years to encourage staying current on a mortgage is new and seems like a good approach,” Cecala said.
But as a practical matter, he said, “BofA has more than $2 trillion in mortgage servicing, which translates to more than 10 million mortgage customers. Roughly 10% or 1 million are seriously delinquent or in foreclosure.”
Offering principal reductions to 45,000 troubled borrowers “would amount to less than 5% of its problem loan universe,” Cecala said. “It’s a help, but it’s not a game changer when it comes to heading off foreclosures.”