(Update 1: adds Treasury announcement.) The US Treasury Department, as it continues to revamp the Home Affordable Modification Program (HAMP), announced today an initiative to encourage principal write-downs. The principal reduction plan is one of the changes to HAMP, to be implemented in coming months. The changes will encourage servicers to write-down a portion of mortgage debt as part of a HAMP modification, allow more borrowers to qualify for modification and help borrowers move into more affordable housing when modification is not possible, according to a fact sheet on the improvements provided to HousingWire. Most notable among the new initiatives is the requirement that servicers consider “principal relief” including write-downs. “This alternative modification approach will include incentive payments for each dollar of principal write-down by servicers and investors,” Treasury said in a statement today. “The principal reduction and the incentives will be earned by the borrower and lender based on a pay-for-success structure.” The principal reduction initiative is geared toward borrowers with excessive negative equity. The write-downs will apply only to borrowers with 115% or higher loan-to-value (LTV) ratios. Servicers will initially forbear some or all of the balance exceeding 100% of the home’s value, down to a 31% debt-to-income ratio. Then, the servicer will forgive the forborne amount in three equal installments over three years, contingent on the borrower’s ability to remain current on payments. Borrowers faced with unemployment – therefore, a lack of income to calculate the debt-to-income ratio targeted under HAMP – will be able to have payments temporarily reduced to an affordable level for three to six months.Treasury is also clarifying borrower outreach and communication requirements, increasing incentives available to servicers and extending those incentives to borrowers with mortgages insured by the Federal Housing Administration (FHA). The Treasury also announced adjustments to FHA programs that will provide more refinancing options to borrowers with negative equity due to large local declines in home prices. The new FHA loan should re-equify the borrower by reducing the amount owed on the original loan by at least 10% and resulting in a principal amount less than the home value. After refinance, the combined first mortgage and any secondary liens cannot surpass 115% of the current value of the home. “This refinancing will help homeowners by setting monthly payments at affordable levels and decreasing the mortgage burden for families owing significantly more than their homes are worth,” Treasury said. “Keeping more responsible families in their homes should support the continued recovery of the housing market.” For borrowers that cannot complete a modification, there’s the Home Affordable Foreclosure Alternatives (HAFA) program, which ends in a short sale. Treasury said today it will double relocation assistance payments to borrowers that elect HAFA, as well as increase incentives for servicers and lenders in order to increase participation in this program. Laurie Maggiano, Director of Policy in the Office of Homeownership Preservation at the Treasury, indicated yesterday during a Webinar hosted by HousingWire that a significant announcement around HAFA was in the works. The Treasury yesterday announced sweeping improvements to the way servicers actively solicit borrowers for participation in HAMP, even from the protection of bankruptcy. Beginning June 1st, servicers must pursue early intervention, pre-screening every borrower that misses two or more payments to determine eligibility for HAMP and soliciting those qualifying borrowers for HAMP participation. The news of a HAMP principal reduction program comes after Bank of America (BAC) introduced this week an earned principal forgiveness program in which a forborne amount of principal will gradually be forgiven over a five-year period. Analyst commentary on the program suggests it bears adverse implications for the payout of certain non-agency mortgage-backed securities (MBS). In particular, the program presents a “clear negative” for junior mezzanine and subordinate debt holders, as well as moral hazard risk as borrowers intentionally default to receive principal forgiveness. Write to Diana Golobay. Disclosure: The author holds no relevant investment positions.