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Federal and state officials announced Thursday morning a $25 billion deal with the nation’s largest banks aimed at offering struggling homeowners mortgage relief. CNBC’s Diana Olick reports.

American homeowners can breathe (a small) sigh of relief. The U.S. announced a $25 billion deal Thursday with the nation’s largest banks – after more than a year of bickering and about-faces – that would provide some help for people struggling to pay their mortgages.

The settlement comes after evidence emerged late in 2010 that banks robo-signed thousands of foreclosure documents without properly reviewing paperwork. The Obama administration hopes the pact will open a new avenue for housing relief because it will force the banks to write down mortgages at a time when roughly one in four borrowers owe more on their mortgage than their home is worth.

Principal reductions have been done on a voluntary basis by banks, often on a limited basis.

“This agreement — the largest joint federal-state settlement ever obtained — is the result of unprecedented coordination among enforcement agencies throughout the government,” said Attorney General Eric Holder in a statement.

“It holds mortgage servicers accountable for abusive practices and requires them to commit more than $20 billion towards financial relief for consumers.  As a result, struggling homeowners throughout the country will benefit from reduced principals and refinancing of their loans.  The agreement also requires substantial changes in how servicers do business, which will help to ensure the abuses of the past are not repeated,”  Holder added. 

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The Obama administration has estimated that up to 1 million homeowners could benefit from the deal through mortgage writedowns and other forms of relief. The New York Times said another 750,000 people who lost their homes through foreclosures between January 2008 through the end of last year will get a $2,000 check. The aid will be doled out over three years, the Times said.  

The settlement has been billed as complementing other government programs designed to boost the housing market that has been a drag on the economic recovery, a key issue for President Barack Obama as he fights for re-election in November.

The core group of banks involved in settlement talks are Bank of America Corp, Wells Fargo Co, JPMorgan Chase Co, Citigroup Inc and Ally Financial Inc.

Forty-nine states joined the settlement in advance of a Feb. 6 deadline, but several states continued negotiations to address concerns specific to their state. The deal was clinched after California and New York joined at the last minute. Oklahoma was the lone holdout and will get no funds.

Although the deal with 49 states is the largest joint federal-state settlement ever obtained, the amount is minuscule compared to the declines in home values and the banks still face a host of other mortgage-related lawsuits.

“The bottom line about this settlement, is it’s okay, it’s a step forward, it’s a step in the right direction. But let’s not kid ourselves, there’s a hell of a lot more that needs to be done,” said Ira Rheingold, executive director of the National Association of Consumer Advocates.

The deal does little to ease bank investor fears, industry analysts said.

“We believe any initial euphoria over the deal will quickly fade as investors realize the flood of additional mortgage-related litigation that the major banks face,” said Guggenheim Partners analyst Jaret Seiberg in a note on Thursday.

The proposed settlement distributed last month to state officials included rough estimates on the benefits each state’s homeowners might receive, but did not include guaranteed numbers.

California received a guarantee its struggling homeowners would receive around $8 billion in relief, two people familiar with the negotiations said. The state itself would receive around $430 million for foreclosure prevention and other housing efforts.

Money breakdown 
Under the terms of the agreement, the servicers are required to collectively dedicate $20 billion toward various forms of financial relief to borrowers. At least $10 billion will go toward reducing the principal on loans for borrowers who, as of the date of the settlement, are either delinquent or at imminent risk of default and owe more on their mortgages than their homes are worth.

At least $3 billion will go toward refinancing loans for borrowers who are current on their mortgages but who owe more on their mortgage than their homes are worth. Borrowers who meet basic criteria will be eligible for the refinancing, which will reduce interest rates for borrowers who are currently paying much higher rates or whose adjustable rate mortgages are due to soon rise to much higher rates.

Up to $7 billion will go towards other forms of relief, including forbearance of principal for unemployed borrowers, anti-blight programs, short sales and transitional assistance, benefits for service members who are forced to sell their home at a loss as a result of a Permanent Change in Station order, and other programs.

Because servicers will receive only partial credit for every dollar spent on some of the required activities, the settlement will provide direct benefits to borrowers in excess of $20 billion.   

The Office of the Comptroller of the Currency also said on Thursday that Bank of America, Citigroup, JPMorgan and Wells Fargo have agreed to pay a penalty of $394 million as part of a settlement they reached in April 2011 with regulators over foreclosure abuses.

The banks can meet the terms of the penalty through payments they make as part of the larger settlement with state attorneys general and the Justice Department, the OCC said.

Reuters and The Associated Press contributed to this report. 

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