Under pressure from Massachusetts Attorney General Martha Coakley, Bank of America Corp.
Bank of America pledged to offer an earned principal forgiveness of up to 30 percent for homeowners nationwide who owe more than 120 percent of the value of their home.
The U.S. bank, the largest in terms of assets, has about 1.5 million home loans behind on payments by 60 days or more.
The plan, to begin in May, is the first by a U.S. mortgage lender to take a systematic approach to reducing mortgage principal to tackle the thorny issue of preventing foreclosures when home values drop well below the amount owed.
The forgiveness would be offered in two stages for the riskiest loans, including subprime loans and loans that offered borrowers multiple options for how much to pay each month.
Ineligible are 30-year fixed-rate loans.
The lender will first offer an interest-free forbearance of principal that the homeowner can turn into forgiven principal annually over five years, provided they stay current on their payments.
TYING FORGIVENESS TO PERFORMANCE
The forgiveness can let a homeowner bring the loan value back down to 100 percent of the home's value over five years.
Barbara Desoer, president of Bank of America Home Loans, said that while earned principal forgiveness helps homeowners, it also recognizes and addresses the interests of mortgage investors by ensuring that forgiveness is tied to the homeowner's performance.
She added that this process lowers the probability of a future default under the modified terms and adjusts the total amount to be forgiven in light of any gains in property values that might occur in an economic recovery.
The announcement comes as U.S. lawmakers and housing advocates are becoming increasingly vocal about the need for principal write-downs in order to save homes from foreclosure on a large scale.
We fully expect an (Obama) administration effort to encourage a shift to mortgage write-downs as a primary effort to stabilize the housing market, said Howard Glaser, a mortgage industry analyst in Washington.
Amid stubbornly high unemployment, homeowners are seen as more likely to simply abandon an unaffordable mortgage when they have no equity or are deep underwater on the loan.
A $75 billion Obama administration program aimed at helping struggling homeowners avoid foreclosure was sharply criticized on Tuesday by a watchdog, which said the program has been oversold and is likely to be a failure when it wraps up in 2012.
The U.S. Treasury and other major mortgage servicers are examining the possibility of a wider adoption of the principal reduction program, said Jack Schakett, credit loss mitigation strategies executive for Bank of America Home Loans.
They're very interested in this concept, Schakett told reporters in a teleconference.
The announcement comes days after two Washington state residents sued Bank of America for allegedly reneging on a promise it made to modify troubled mortgages when it took $25 billion in taxpayer bailout money.
The lawsuit alleged that the lender has seriously strung out, delayed and otherwise hindered modifications because it had financial incentives to do so.
(Additional reporting by Joe Rauch in Charlotte, North Carolina and David Lawder in Washington; Editing by Kenneth Barry)