What the foreclosure settlement means for you

NEW YORK (CNNMoney) -- The $26 billion foreclosure settlement has finally been given the green light, making it possible for roughly two million of the nation's hardest hit borrowers to see a significant reduction in their mortgage payments.  Agreed to between the nation's five largest banks and attorneys general from 49 states and the District of Columbia, the deal settles charges of foreclosure processing abuses dating back to 2008.  Under the settlement, which was approved by a federal judge on Thursday, the banks will reduce the principal on loans held by underwater homeowners, refinance some mortgages to today's low interest rates and compensate those who lost their homes due to improper foreclosure practices.  The banks also agreed to change the way they handle and approve foreclosures.

The group of state attorneys general claimed that banks lost important paperwork, cut corners and enlisted robo-signers to attest to facts they had no knowledge of on hundreds of documents a day. The settlement, the details of which were first announced in early February, has been in the works for more than a year. Here's what the banks agreed to and what borrowers can expect in the days ahead.  What did the mortgage lenders and loan servicers agree to do? The banks and servicers have committed at least $17 billion to reduce principal for borrowers who 1) owe far more than their homes are worth 2) are behind on payments. The amount of principal reduction will average about $20,000 per borrower in the cases of four of the banks. The Bank of America reductions will be even steeper, averaging $100,000 or more, according to spokesman Rick Simon. Another $3 billion or more will go toward refinancing mortgages for borrowers who are current on their payments. This will enable them to take advantage of the historically low interest rates that are currently available.

The banks will pay $5 billion to the states and the federal government, the only hard money involved in the deal. Out of that fund will come payments of $1,500 to $2,000 to homeowners who lost their homes to foreclosure. Other funds will be paid to legal aid and homeowner advocacy organizations to help individuals facing foreclosure or experiencing servicer abuses.  Another $1 billion will be paid directly by Bank of America to the Federal Housing Administration to settle charges that its subsidiary, Countrywide Financial, defrauded the housing agency.  The exact amount of the payments will depend on how many people participate in this part of the settlement. They will share equally in a pool of $1.5 billion. The U.S. Department of Housing and Urban Development expects about 750,000 former homeowners to take part. In addition, the banks agreed to eliminate robo-signing altogether and to use proper and legal procedures when putting homeowners through the foreclosure process. They also agreed to end servicer abuses, like harassing delinquent borrowers for payments, and to include principal reductions more often in their mortgage modifications programs. (Court approves $26 billion foreclosure settlement)

Is my mortgage lender taking part in this settlement? Bank of America (BAC, Fortune 500), Wells Fargo (WFC, Fortune 500), JPMorgan Chase (JPM, Fortune 500), Citigroup (C, Fortune 500) and Ally Financial (GJM) are taking part in the settlement.  Loans owned or backed by Fannie Mae (FNMA, Fortune 500) and Freddie Mac (FRE), however, are not part of the deal nor are loans insured by the Federal Housing Administration eligible. (The $26 billion crapshoot) The Federal Housing Finance Agency, which oversees the two government-sponsored mortgage giants, said it will not allow any balance reductions for loans insured by the companies under the settlement, defying pressure to do so from both the public and from policy makers.  There could be a separate deal made with some smaller lender-servicers, according to Geoff Greenwood, spokesman for the Iowa attorney general's office. He said the attorneys general have started working on an agreement with several other banks, which combined represent a much smaller percentage of mortgage loans than those held by the big five lenders that are already participating in the settlement.  What should I do if I think I may qualify for a principal reduction or refinanced mortgage? Contact your lender/servicer and ask them to review your case.  If I take the money, what rights do I give up? Individual borrowers do not give up any right to sue.  As part of this deal, state attorneys general gave up the right to sue the mortgage servicers for foreclosure abuses arising out of the robo-signing scandal. However, they reserve the right to sue -- or press charges for criminal behavior -- if they uncover improper acts when the loans were originated or when they were securitized.  When will the new rules and bank policies be put into place? Most of them have already become part of bank policies. When will homeowners find out if they're eligible for a principal reduction or refinancing? The banks have said they expect to get started very quickly. The first step will be to identify borrowers who qualify for the deal. Since March 1, Chase has been reviewing all borrowers who apply for mortgage modifications in order to determine if they might qualify for a principal reduction, according to spokeswoman Amy
Bonitatibus.  Wells Fargo's spokeswoman Vickee Adams said the bank will start sending out letters to borrowers on Monday, informing them if they may be eligible.  Bank of America has already begun sending trial principal reduction plan offers to customers who were already enrolled in either the Home Affordable Modification program, the government-sponsored initiative to reduce borrowers' mortgage costs, or the bank's proprietary modification pipeline, according to bank spokesman, Rick Simon. (Bank of America to slash mortgage balances by $100,000 or more)

He said details regarding the bank's refinancing initiative under the settlement deal are still being finalized and the bank expects to contact borrowers about those modifications within a couple of months.  Citibank also started rolling out the plan, according to its spokesman, Mark Rodgers. It has fielded inquires from customers since March 1 and identified some as qualifying for help under the settlement. "We have already moved a few hundred cases into the pipeline," he said. Ally Financial had not yet commented when this story when to press.. Under the settlement, the principal reductions, refinancings and payments must be completed within three-and-a-half years. However, the state attorneys general and the Department of Housing and Urban Development want the bulk of the settlement actions completed within 12 months. Would I have to pay taxes on the principal reductions or the pay-outs? If the principal is reduced in 2012, it will not be subject to income tax.
That's because the Mortgage Debt Relief Act of 2007 allows taxpayers to exclude income from the discharge of debt on their principal residence. The act is scheduled to expire at the end of this year, however.  So if the act is not extended and the principal reduction occurs in 2013, borrowers may be on the hook to pay taxes on the settlement amount. (Principal reductions are far and few between)
It's not clear whether you would have to pay taxes on the $1,500 to $2,000 payout. The IRS declined to comment on the question. Which state didn't participate and what does it mean if you live in that state? Oklahoma was the only holdout of the 50 states. Instead, it announced its own settlement with the five banks in early February.  Under its settlement, the banks agreed to pay $18.6 million in damages, part of which would compensate homeowners who were victims of unlawful and unfair mortgage practices, according to the Oklahoma attorney general's office.  Homeowners who believe they may have been wrongly foreclosed upon should visit the Oklahoma attorney general's web site and fill out the paperwork for processing a claim.  Will the settlement make it harder to get a mortgage? The new rules and regulations the banks have agreed to under the settlement should have little impact on future mortgage borrowing since most of practices are already in place, said Keith Gumbinger of HSH.com, a mortgage information provider.  The actual cost to the banks of the settlement should not discourage lending either. (Housing: The one bailout America really needs)
Only $5 billion of the $26 billion settlement will be a direct expense to the banks. The remainder will be the cost of modifying mortgages. Many of those modifications may be in the best interests of the banks to make, however, since the alternative may be foreclosure, which can cost banks more than modifications.
Do you think the banks owe you money? Have you been contacted about the foreclosure settlement? Send your story and contact information to Leslie Christie and you could be featured in an upcoming article on CNNMoney.
Correction: An earlier version of this story put the amount allocated to refinancing loans at $3.7 billion.