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Bank of America's Home Loan Forgiveness Plan is Limited

The last thing that mortgage companies want to do is forgive their customers' debts. Bank of America will make an exception for a few borrowers.

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Around 45,000 homeowners will be offered reductions in mortgage debt as part of the bank's foreclosure-avoidance effort. If all of them accept the offer, and if all of those customers faithfully make their reduced monthly payments for the next five years, the amount forgiven could total $3 billion.

Before you get your hopes up, keep this in mind: These 45,000 borrowers are a small subset of the bank's customers. Principal forgiveness will be offered only to people who got certain kinds of loans from Countrywide Home Loans. Bank of America bought Countrywide in 2008.

When Bank of America bought Countrywide, it took possession of $25 billion in pay-option adjustable-rate mortgages. That's how much the customers owed on pay-option ARMs; their total value as an investment was $13.9 billion last September, because Bank of America knew that billions of dollars' worth of these loans would go belly-up eventually.

Countrywide did a lot of subprime loans, too. Bank of America stayed away from subprime. But when B of A bought Countrywide, it ended up with $1.8 billion in Countrywide's subprime ARMs on the books. The borrowers who got those loans may be eligible for principal forgiveness, too, along with a few people who got prime, two-year ARMs from Countrywide.

Bottom line: Principal forgiveness may be offered to 45,000 customers who got pay-option and subprime ARMs from Countrywide. If your loan officer sported a Bank of America ID badge, you won't be offered principal forgiveness, because you didn't get your mortgage from Countrywide.

What is a pay-option ARM?

Pay-option ARMs are adjustable-rate mortgages in which the borrower chooses the payment. The borrower usually has four options. One option is to pay less than the interest accumulated that month. In other words, the borrower might rack up $1,200 in interest in a given month, but have the option of paying $1,000. The $200 difference was added to principal. After making the minimum payment, the borrower owed more on the house. When borrowers end up owing more after making a payment, it's called negative amortization. According to an SEC filing, 72 percent of pay-option customers made negative-amortization payments in June 2008. From July through September last year, half did.

"In our experience, we have found that severely underwater homeowners are reluctant to accept a solution that does not offer some reduction in principal," says Barbara Desoer, president of Bank of America Home Loans.

Bank of America says it will offer principal reductions as the first step of HAMP-style loan modifications to this 45,000-strong subset of Countrywide customers. Pay-option ARM customers will get a different offer from subprime ARM customers.

For pay-option ARM customers, Bank of America will offer to forgive some or all of the debt that was added as negative amortization. If all of the negative-amortization debt is erased, the customer still ends up owing the original mortgage amount.

Forgiving principal

If that's not enough to qualify for a modification under HAMP guidelines, then Bank of America moves to the next stop: "earned principal forgiveness."

Earned principal forgiveness may be offered on subprime ARMs as well as on pay-option ARMs. To qualify, the borrower has to owe at least 20 percent more than the house is worth. For these customers, Bank of America will "forbear principal" for five years. The bank will forbear as much as 30 percent of the loan amount, down to 100 percent of the home's current value.

"Forbear principal" means you still owe the money, but the bank doesn't charge interest on the entire loan amount. For example, if you owe $120,000, and the bank forbears $20,000, then you pay interest on $100,000—but you still owe $120,000.

If Bank of America forbears part of the amount you owe, you can have some of that debt forgiven if you stay current on the loan. One-fifth of the forborn amount is forgiven each year if you make your payments on time. That happens for at least the first three years.

In the fourth and fifth years, debt won't be forgiven if the home's value has risen and you're no longer upside-down on the loan. "This helps strike a critical balance between customer and investor interests," says Jack Schakett, who heads Bank of America's loss-mitigation efforts.

The bank's message to borrowers who think they might be eligible for this program: Don't call us, we'll call you. Schakett says that every month, the bank evaluates its customers' payment histories, amount owed and estimated home value. The bank will contact borrowers who might qualify for the program, beginning in May.

Schakett estimates that the average amount of principal forgiveness or forbearance will be around $62,000 to $65,000. If 45,000 people take the offer and ride it to completion, that will total around $3 billion.

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