If you took out an unaffordable subprime mortgage or option ARM through Countrywide Financial, you may be able to get a new, more affordable loan.

Nearly 400,000 Countrywide mortgage holders will be able to modify their loans after Bank of America, which bought Countrywide this year, announced Oct. 6 that it had settled a lawsuit with California and Illinois.

Countrywide also plans to modify loans for homeowners in nine additional states that joined the suit: Arizona, Connecticut, Florida, Iowa, Michigan, North Carolina, Ohio, Texas and Washington.

Homeowners in other states may be able to participate if their state agrees to join the settlement.

"The basis of the lawsuit was that Countrywide was engaging in deceptive practices, basically putting people into homes they couldn't afford," said Natalie Bauer, spokeswoman for Illinois Attorney General Lisa Madigan. "This enables homeowners to modify their loan terms to be able to stay in their homes."

The settlement is, without a doubt, the biggest and best foreclosure prevention effort we've seen since the mortgage crisis began in 2007 and foreclosures soared to record highs.

Bank of America will spend more than $8 billion to reduce the interest or principal on costly loans so that borrowers can afford the monthly payments and keep their homes.

It's the first time any lender has agreed to make mandatory loan modifications since the mortgage crisis began, Bauer said.

That is a critical distinction, because the voluntary foreclosure prevention programs, such as HOPE NOW, that the Bush administration negotiated with lenders have been a big disappointment.

The banks and mutual funds that own the debt have been extremely reluctant to reduce interest rates and write off debt, as Bank of America now promises to do.

This settlement also is a huge breakthrough because Countrywide was the nation's largest originator of prime and subprime mortgages until its collapse this year. A huge part of the overall mortgage crisis can be traced to Countrywide's deceptive loans.

The settlement calls for Bank of America to:

• Suspend foreclosures on the riskiest loans to examine what refinancing options homeowners have. If you are facing an immediate foreclosure, Countrywide suggests you call 1-800-669-6607 immediately to talk with a representative about your options, which will halt the foreclosure process.
• Create a $150-million Foreclosure Relief Fund for borrowers with subprime and option ARM loans who lost their homes because of early payment default or default when the interest rate reset. To qualify, you must have made six payments or less and have experienced a foreclosure sale. Each state will get a portion of the $150 million, based on how many eligible borrowers it has; the portions will be divided among the state's borrowers. By calling the number listed above, you can find out if you're entitled to any money.
• Offer money for relocation assistance to homeowners facing immediate foreclosure. The first goal is to keep you in your home. However, if you call to modify your loan and have no income or don't feel you could handle an interest rate of 2.5% and choose not to stay in the home, Countrywide will try to work out relocation assistance. Countrywide has allotted a minimum of $70 million and anticipates payments to 35,000 borrowers, which means each borrower would get about $2,000.

To qualify for a modified loan, you have to live in your home and have paid for it with a Countrywide subprime ARM or pay-option ARM originated before Dec. 31, 2007.

The current loan-to-value ratio must be 75% or higher.

Starting Dec. 1, Countrywide will begin contacting borrowers who are more than 60 days behind on their payments or at risk of defaulting because of an upcoming increase in the adjustable interest rate.

It will renegotiate the terms of those loans to ensure that payments don't exceed 34% of their income.

Homeowners will be contacted first by mail and then by phone as needed, said Jumana Bauwens, Countrywide's senior vice president for corporate communications.

If possible, borrowers will be refinanced into a fixed-rate loan guaranteed by the Federal Housing Administration under the Hope for Homeowners Program.

If homeowners can't qualify for an FHA loan, Countrywide will allow borrowers with:

Adjustable-rate, subprime loans to keep their initial subprime teaser rate for five years. If they can't afford the teaser rate, the interest rate could be dropped as low as 3.5%.

Option ARMs to convert their loans into fixed-rate or 10-year, interest-only loans with the interest rate reduced to as little a 2.5% in order to bring the payments down to no more than 34% of the borrowers' income.

Subprime, fixed-rate loans to reduce their interest rate to as little as 2.5%.

Countrywide also is picking up the tab for the refinancing. The lender will waive all prepayment penalties and won't charge loan modification fees.

That's good news for troubled and at-risk homeowners.

However, if you are currently facing foreclosure, waiting until Dec. 1 to talk to Countrywide may not be an option.

If you have a foreclosure sale pending, Bauwens suggests you contact Countrywide immediately at 1-800-669-6607 to stop the foreclosure process and talk to a representative about your refinancing options.

If you're interested in foreclosure assistance, are currently defaulting on your mortgage payments or are afraid you might, find out what it takes to refinance through Hope for Homeowners, or call Bank of America at 1-800-669-6607 to discuss modifying your home loan.

By Erin Brereton

Interest.com Contributing Editor

Have a question about your finances? Ask us at editors@interest.com.