Bank of America (BofA) has begun implementation of an earned principal forgiveness approach to modifying certain loans eligible for its National Homeownership Retention Program (NHRP).

According to BofA, the plan will be offered to homeowners who owe considerably more on their loan than the current value of their home, when the loan is being considered for modification through the government’s Home Affordable Modification Program (HAMP).

BofA unveiled this approach to employing a principal reduction as the first step toward reaching HAMP’s affordable payment target of 31% of household income when modifying certain NHRP-eligible mortgages – ahead of lowering the interest rate and extending the term. The reduced principal balance will be a non-interest bearing forbearance amount, and the homeowner may earn forgiveness of the forborne amount by remaining in good standing on payments.

NHRP-eligible loans include subprime, Pay-Option ARM and prime-quality two-year hybrid ARM loans originated by Countrywide on or prior to January 1, 2009, if the amount of principal owed exceeds the current property value by at least 20% and the loan is 60 days or more past due.

As part of the alignment, BofA may offer earned principal forgiveness over a five-year period, as it announced in March, or over the three-year time frame that Treasury intends to include in its HAMP principal forgiveness design, depending on individual borrower situations.

Jack Schakett, credit loss mitigation executive for BofA Home Loans, said: “Our tests have shown that many homeowners who are severely underwater on their mortgages will respond positively to a modification offer that includes reduction of their principal balance, increasing the rates of acceptance of HAMP trial modification offers, conversion to permanent modifications and long-term success of the homeowner.

“Encouraging more borrowers in this situation to accept a homeownership retention solution may help stabilize the surrounding community to the benefit of neighboring homeowners.”