Bank of America (NYSE: BAC) To Cut Borrowers' Balances in New Mortgage Deal

In addition to last month's settlement, Bank of America (NYSE: BAC) announced Thursday it would cut qualified borrowers' balances by even more than originally agreed to in a side mortgage deal with U.S. authorities.

The bank said it would slash loan balances by an average $100,000. If Bank of America meets the provisions of the mortgage deal - which includes a separate agreement to reimburse HUD $1 billion for loan-related issues - within three years, it will be forgiven $850 million in penalty payments.

The biggest U.S. mortgage lenders, including Bank of America, finally reached a $25 billion mortgage settlement last month to help homeowners. The provisions to the mortgage settlement included $5 billion total in cash penalties, payable to borrowers, states, and the federal government, and $20 billion in additional aid reached by reducing homeowners' loan balances, and refinancing for underwater homeowners.

Bank of America is the biggest party involved in the $25 billion settlement. The company owes $3.24 billion in cash payments to federal and state governments, plus $8.58 billion of principal write-downs, refinancings and other assistance.

This first settlement was supposed to reduce mortgage balances by an average of about $20,000 for roughly 1 million underwater homeowners.

Now Bank of America plans to reduce the amount many homeowners owe to 100% of the current market value. The bank said about 200,000 homeowners qualify and it will start to reach out to them as soon as the new mortgage deal is approved by a federal court.

The remaining four lenders - JPMorgan Chase & Co. (NYSE: JPM), Wells Fargo & Co. (NYSE: WFC), Citigroup Inc. (NYSE: C), and Ally Financial Inc. - are expected to reduce qualified borrowers' principal to between 115% and 125% of the value of their homes.

While homeowners stand to gain from the mortgage deal, investors holding mortgage-backed securities (MBS) could lose as the principal reductions reduce the value of their securities.

HUD Secretary Shaun Donovan said principal reductions will be done only when there is a benefit to investors, meaning the cost of the principal reduction will be less over time than taking the loan through foreclosure.

Mortgage Deal Ongoing Fight for Homeowners, Bank of America (NYSE: BAC)

The government hopes the deals will hurry a housing recovery and allow more homeowners to keep their homes, while avoiding more lengthy foreclosures.

The five main players in the mortgage deal handle payments for 55% of all outstanding home loans, according to Inside Mortgage Finance.

In order to get the first deal rushed through after 16 months of negotiations, the banks opted for a broad mortgage settlement that kept them liable for other misconduct - meaning the banks could face more expensive legal costs in the future.

"Because of the narrow nature and the fact that the banks didn't get the widespread assurances they were seeking, this was mostly meaningless," David Lykken of Mortgage Banking Solutions told Bloomberg News.

The other liabilities include packaging bad loans into securities and allowing billions of dollars in investments to fuel a market vehicle designed to collapse. The mortgage settlement also won't prevent states from pursuing claims regarding banks' database use to conduct foreclosures.

New York Attorney General Eric Schneiderman is determined to hold big banks accountable. He filed a lawsuit Feb. 3 against Bank of America, JPMorgan, and Wells Fargo for fraudulent use of the Mortgage Electronic Registration Systems, or MERS. Schneiderman claims use of the mortgage-registering database sped up the process of bundling bad mortgages into securities.

"The conduct that led to the crash is still fair game," Schneiderman told The Washington Post. "I'm confident the releases are narrow enough so our investigation into misconduct should produce more significant relief going forward."

U.S. President Barack Obama pledged support in his State of the Union address Jan. 24. He announced the creation of a mortgage crisis unit to investigate the real estate lending actions of big banks.

Bank of America (BAC) fell Friday 0.12% to close at $8.05.

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