Bank of America, one of five banks in $25 billion settlement with the government over foreclosure practices, has struck a side deal that will allow it to reduce penalties in return for bigger cuts to borrowers' mortgage balances, the Wall Street Journal said.

Bank of America will make deeper and broader cuts than other banks, which will allow it to avoid as much as $850 million in penalties and give more than 200,000 financially strapped households the opportunity to sharply reduce their mortgage balances, the paper said.

The side deal is unique to Bank of America, the Journal said, citing a senior administration official. It added that many of the write-downs will be made on loans originated by Countrywide Financial Corp, which Bank of America bought in 2008, and then packaged into securities.

Investors in those securities could then be affected by the side deal.

Bank of America said on February 9 that under the government settlement, write-downs will be made on loans originated by Countrywide Financial Corp prior to and for a period following the bank's acquisition of that lender.

Borrowers who qualify are expected to receive principal reductions averaging more than $100,000, Bank of America spokesman Dan Frahm told Reuters.

The side deal offers qualifying borrowers a chance to cut their mortgage balances to their home's current market value. Whereas other banks are required under the national settlement to cut principal to no more than 120 percent of the home's value, the Journal said.

Bank of America, the bank with the most liability from the fallout of the housing crash, is set to pay the lion's share of the government's settlement, around $11 billion of it.

The other banks accused of abusive mortgage practices that settled with the government were Wells Fargo & Co, JPMorgan Chase & Co, Citigroup Inc and Ally Financial Inc.

(Reporting by Sakthi Prasad; Editing by Edwina Gibbs)