WASHINGTON — The settlement documents filed by state and federal officials on Monday would allow Bank of America Corp. and Ally Financial Inc. to avoid millions in additional penalties by agreeing to make broader principal reductions for underwater borrowers.

Bank of America would avoid $850 million in additional penalties for providing broader principal reductions than other banks for loans in its Countrywide portfolio. The settlement requires the bank to conduct a one-time mortgage modification program for first-lien mortgages that would reduce a borrower's debt-to-income to 25%, and reduce the loan to 100% of its current value. (Other banks are required to reduce loan-to-value ratios to no more than 120%.)

The settlement also requires the bank to solicit all potentially eligible borrowers, including borrowers who were more than 60 days delinquent as of Jan. 31. The program would include a 90-day trial period, after which the modification would become permanent if the borrower remains current.

The credit for these modifications will be calculated the same way as it is for other first-lien principal forgiveness, but the bank won't be able to count the credit for these loans toward their settlement obligation until it exceeds the minimum requirements under the settlement. The penalties owed will be offset by the amount that the bank exceeds minimum requirements for borrower relief.

Bank of America has three years after the settlement takes effect to comply with the requirements, which will be certified by the settlement monitor, former North Carolina Banking Commissioner Joseph Smith.

In a similar side deal, Ally also agreed to implement several modification programs for loans originated prior to Jan. 1, 2009, including one that would reduce a borrower's principal to no more than 105% of the home's value, and reduce monthly payments by at least 10%.

For some borrowers who are in "imminent risk of default" — including those with interest only loans or other high-risk products — the bank will provide "payment shock relief" that would reduce a borrower's principal to no more than 100% of the home's value.

A third modification program would reduce principal balances to as much as much as 85% of the loan's value, and reduce monthly payments by at least 30%.

Ally has also agreed to develop a refinancing program that would allow borrowers to refinance into a new fixed-rate mortgage at current conforming rates, reduce monthly payments by at least $100, and guarantee no future interest rate increases or additional costs to the borrower.

Like Bank of America, Ally would receive the same amount of credit for these modifications as it would for other kinds of principal reduction.

Ally also promised to ensure that its Residential Capital mortgage subsidiary would continue to meets its obligations under the settlement in the event of a sale or reorganization.

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