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In preparation for the deluge of foreclosures expected to wash over California and the country by the end of 2010, Bank of America (B of A) has released information on a new program: a $3 billion principal reduction program for homeowner’s with loan-to-value (LTV) ratios exceeding 120% of the home’s current market value.

However, this program is geared to engage only those homeowners who have either an option-ARM or a two-year rollover ARM structured to allow negative amortization of up to 125% of the original loan amount. Further, to qualify for the program, the homeowner must be in default for at least 60 days on his mortgage.

Homeowners who qualify for B of A’s principal reduction program will find their loan balances divided into two parts. One part of the principal will bear interest and be amortized, while the other part will not. The non-interest bearing principal will be maxed out at 30% of a loan’s balance. It is this non-interest bearing principle that B of A is labeling as conditionally available for future write-off.

What B of A has hidden in their loan reduction program is the interest-bearing part of the principal, which is not available for future discount, will be reset immediately on modification to amortize over the remaining term of the 30-year loan. This means higher monthly payments for most of those homeowners who could not previously make their payments and have already defaulted – a requisite to apply for this program.

The non-interest bearing principal set aside for possible future write off is the only amount which qualifies for the conditional reduction. During each of the program’s first three years, one fifth of the non-interest bearing amount (a maximum of 6% of the entire loan balance) will be written off annually so long as the homeowners remains in “good standing” – no delinquency for more than 60 days during the year. However, the only people eligible for this program are those already over 60 days delinquent.

After three years, the remaining two fifths of principal available for write off (a maximum of 12% of the total loan amount) is at the mercy of rising housing prices. For the fourth and fifth years, B of A turns the homeowner’s ARM into something even more horrendous: a price level adjustment mortgage (PLAM), a mortgage product not heard of since the wild inflationary days of the late 1970’s. When a homeowner is subject to PLAM adjustments, they relinquish their ownership hedge against price inflation and appreciation. And, as commonly believed by most real estate market onlookers, housing prices are on the brink of rising again, especially by 2014 and 2015.

In the fourth and fifth year of this principal reduction program, if a homeowner’s property price has risen enough (a point presently unknown), the two fifths of the remaining non-interest bearing principal (12% of the loan) will no longer be available for write off and be dumped back onto the interest bearing principal, and payments reset (upward) to fully amortize the newly increased principal.

If B of A truly wishes to do society a favor, they will not only permanently reduce the principal on all these toxic ARM loans to LTV levels of 94% in order to make the homeowner solvent and capable of building an equity or selling, but they will also turn these explosive short-term ARMs into true real estate loans – long-term, fixed rate mortgages.

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Tagged as: Cramdown, HAMP, lender, principal reduction, strategic default, underwater