WASHINGTON (CNNMoney) — In the largest deal to date aimed at addressing the housing meltdown, federal and state officials on Thursday announced a $26 billion foreclosure settlement with five of the largest home lenders.
The deal settles potential state charges about allegations of improper foreclosures based on robo-signing, seizures made without proper paperwork.
The settlement includes the Justice Department and the U.S. Department of Housing and Urban Development, as well as 49 state attorneys general — all but Oklahoma.
“We are using this opportunity to fix a broken system,” said U.S. Attorney General Eric Holder at the news conference announcing the settlement.
Most of the relief will go to those who owe far more than their homes are worth, known as being underwater on the loans. That relief will come over the course of the next three years, with the banks having incentives to provide most of the relief in the next 12 months.
“This settlement is about homeowners, homeowners in distress,” said Iowa Attorney General Tom Miller.
What the settlement means to you
Principal reduction: At least $17 billion will go to reducing the principal owed by homeowners who are both underwater and behind on their mortgages.
Depending on which loans have principal cut, the total amount of relief could reach as much as $34 billion.
Federal officials say that portion of the settlement will provide relief for up to 1 million of the most beleaguered homeowners. But if that many homeowners get the amount they owe pared, it would only be an average reduction of $17,000 in their principal.
Given the fact that many homeowners are far more underwater and will need steeper reductions in order to be able to afford their payments, the number of homeowners who receive help under this part of the program will likely fall far short of the 1 million mark.
Refinancing: Officials say up to 750,000 other underwater homeowners who are current on their mortgages will be able to refinance their current loans at lower rates. They will not receive a reduction in principal, but with mortgage rates now near record lows, they could receive substantial savings on their monthly payments.
The settlement sets aside $3 billion to account for the reduced interest payments the banks will receive after the refinancing.
Robo-signing payments: About $1.5 billion of the settlement will go to homeowners who had their homes foreclosed upon between Jan. 1, 2008 and Dec. 31, 2011, and who meet other criteria. They will receive up to $2,000 each.
Participating banks: The five mortgage servicers that are parties to the settlement — Bank of America (Fortune 500), JPMorgan Chase ( , Fortune 500), Citigroup ( , Fortune 500), Wells Fargo ( , Fortune 500) and Ally Financial — will pay a total of $5 billion to the states. Some of that money will go to foreclosed homeowners and the rest to the states.,
Federal officials say negotiations are underway to expand the settlement to nine other major servicers, which would raise the overall value of the settlement to $30 billion.
The deal is the second biggest settlement involving the states ever reached, trailing only the $206 billion settlement in 1998 between state attorneys general and the tobacco industry.
And it dwarfs any settlements that major Wall Street firms have reached to settle other allegations of misdeeds related to the financial markets meltdown and the Great Recession.
Still it only will help a faction of those homeowners who are struggling with mortgages.
There are 1.5 million homeowners who are 90 days or more delinquent on their mortgages but not yet in foreclosure, according to the most recent estimate from the Mortgage Bankers Association. And CoreLogic estimates that 11 million homeowners are underwater on their mortgages.
Obama proposes new home refinancing plan
The settlement does not preclude criminal prosecutions from being pursued. It also doesn’t stop investigations into other allegations of misdoings, such as the process of bundling loans into mortgage-backed securities and selling them to investors.
The deal is supposed to protect consumers when it comes to robosigning, and ensure that mortgage servicers agree to communicate better, avoid delays and give homeowners who are late on mortgage payments a fairer shake.
New York’s participation had been shaky this week, because some of the banks involved in the multi-state deal had also been sued by Attorney General Eric Schneiderman last week. Those banks — Bank of America, Wells Fargo and JPMorgan Chase — had also asked for a legal pass from Schneiderman’s lawsuit, which accuses them of deceptive foreclosure practices for relying on the Mortgage Electronic Registration System.
On Tuesday, Schneiderman’s office organized a media briefing to talk about the deal and then canceled it minutes before it was supposed to begin.
The big question throughout the negotiations was how much money would be available to help homeowners, which depended on how many states agreed to the deal. California’s participation raises the total settlement value by several billion dollars.
At least one consumer advocacy group, the Center for Responsible Lending, has said the deal — while “no silver bullet” — leaves room to hold banks accountable in other mortgage probes, said Kathleen Day, a spokeswoman for the nonprofit.
But other left-leaning groups, including Move On and the New Bottom Line, are continuing to urge states to hold out for a big criminal investigation and a $300 billion settlement award.
–CNN’s Jessica Yellin contributed to this story.