For Chablis Arnoldy, the state mortgage refinancing program sounded almost too good to be true.

She and her husband, Jason, had tried since 2010 to refinance their $315,000 mortgage but were told they couldn’t because their Bend home had lost so much value in the housing bust.

The Arnoldys thought they had found an answer in the state’s new Loan Refinancing Assistance Pilot Project, for which they received approval in January. But last month, they discovered that Bank of America, which services their loan, would not let them into the program, one of the first of its kind in the country.

While the state program requires participants, who sell their homes in short sales, to live in their houses, Bank of America does not allow short sales if the seller remains in the home.

State officials who run the program say they have been meeting with Bank of America and believe it’s simply a matter of explaining the program to the right people at the bank, the nation’s second largest.

But the conflicting policies have drawn strong criticism from U.S. Sen. Jeff Merkley, D-Ore.

“We should be taking aggressive action to help homeowners in danger of foreclosure,” Merkley said in a statement, adding that the program providing the funding “has started to show substantial promise.”

Banks and loan servicers should “work quickly to cut through the red tape for the benefit of the families and our broader economy.”

The Loan Refinancing Assistance Pilot Project is one of several state programs to offer housing assistance to distressed Oregon homeowners with $220 million in U.S. Treasury funds reallocated from the Troubled Asset Relief Program.

Ten million of those dollars have been put into the pilot project, which seeks to help about 300 homeowners in Deschutes and Jackson counties — two areas hit especially hard by falling home prices — buy new loans based on the current value of their homes.

Under the program, the Arnoldys would effectively perform a short sale on their home — selling it for less than the amount owed — to Further Development LLC, the Portland real estate company contracted by the state to participate in the pilot program.

Further Development would then secure a new mortgage with the lender, based on the current value of the home, and return the refinanced mortgage to the seller.

Chablis Arnoldy said she saw it as the last, best chance to keep the 2,000-square-foot, northwest Bend home she and her husband bought in 2004, while lowering their monthly payments.

But according to Bank of America, a short sale can’t go through while the seller stays in the home — a policy that runs contrary to the state program’s mission: to keep the homeowners in their homes.

Invoking what is known as an arm’s length clause, Bank of America informed the Arnoldys that their state-authorized short sale was rejected.

“Generally, a short sale requires an arms-length transaction, in which the seller will not have an interest in the property after the sale,” Bank of America spokesman Rick Simon told The Bulletin in a statement. Simon added that the bank was participating in other Hardest Hit Fund programs, such as the Mortgage Payment Assistance Program.

In the case of the pilot program, however, without the arm’s length requirement, Simon said, “it may be difficult to get broad participation among mortgage investors who would take the losses and have to approve the sales.”

An arm’s length away

Arnoldy isn’t alone.

Christina Perryman also heard about the program, through her real estate agent, Candy Woodbridge. Like the Arnoldys, Perryman was eager to sign up.

She and her husband, Steve, had bought a home near Mountain View High School in 2005. When she and her husband lost their son, Brandon, to cystic fibrosis in late 2008, the couple “kept struggling” to keep up with their house payments.

They started falling behind the next year. While still working, the emotional toll of their son’s passing was too much to keep up with their payments. By early 2010, they had decided on a short sale, but were also told their home had lost too much value.

The Perrymans applied and also were told that they had qualified, meaning Further Development, the state contractor, had approved their short sale, Perryman said.

Then she got word that Bank of America wouldn’t let the short sale go through.

“This program gave us hope,” Perryman said. “We just want to stay in our home.”

Bank of America doesn’t own their mortgages. The Arnoldys’ mortgage is held by Wilshire Mortgage. Bank of America bought the servicing rights to the mortgage, meaning they are responsible for the collection of mortgage payments. The Perrmyans’ mortgage is held by U.S. Bank, but Bank of America also has servicing rights to their loan.

The Bend families found themselves in this position because their homes each lost more than 50 percent of their values over three years, starting with the housing market bust in late 2008.

By the end of 2011, the value of the home Arnoldy bought for $350,000 had dropped to about $150,000.

The pilot program was set up for just that situation. But when she was notified of Bank of America’s decision to decline the short sale, “I was just speechless,” Arnoldy said. “I thought, how is this possible?”

Other homeowners are having better luck than the Arnoldys and Perrymans in the pilot program.

Total Property Resources, a real estate company with offices in Bend and Portland, has closed deals for several underwater homeowners through Further Development and the pilot program, said David Ambrose, CEO of Total Property.

In the case of Bank of America, there has been some reluctance to let homeowners into the refinancing program, he said. Most of the hold-ups involving the pilot program have centered around the arm’s length clause.

Especially in the case of a short sale, when a bank “is being asked to release collateral, and accept less than they’ve agreed to” under the terms of a mortgage, reluctance to participate wasn’t entirely unexpected.

But invoking the arm’s length clause “is obviously completely inconsistent with the context of the Hardest Hit Fund Program,” Ambrose said, “which by its very nature stipulates that the buyer is going to stay in their home. What’s happening in many cases is that those (arm’s length agreements) have proven to be an obstacle to moving these applicants forward, even though the program was approved by the U.S. Treasury and the State of Oregon.”

Ambrose added: “It’s completely inappropriate to use (arm’s length) conditions as a grounds for rejection of an applicant. It’s going contrary to federal and state policy.”

Each of the Hardest Hit programs is run through the Oregon Homeownership Stabilization Initiative, established when the funds were first made available in 2010.

OHSI spokesman Ben Pray said the program is so new that “we’re still working out how to present it to servicers and investors.”

Pray and other state officials are meeting with Bank of America representatives this week in an effort to encourage them to accept the program on a broader basis.

With respect to the Arnoldys’ and Perrymans’ rejection, Pray said, “We are trying to identify the reasons they were turned down so we can figure out how to better communicate with Bank of America about the program. We want to make sure investors of the loans understand the goal of the program, and we want to collaborate on the mechanisms to make it work.”

Erik Sten, president of Further Development, said he expected the program to encounter some hurdles, calling it “the only thing like it really in the country.”

Sten emphasized that about a half-dozen Deschutes County homeowners have already been accepted into the pilot program, though none with loans serviced by Bank of America.

Using the arm’s length clause as the sole basis for rejection of the Arnoldys’ and Perrmymans’ applications “makes no sense, because there’s no fraud here. These are U.S. Treasury dollars,” Sten said. “It’s one thing to say, ‘We want an arm’s length affidavit to combat fraud.’ It’s another to say, ‘We don’t want a family to stay in their house.’”

Facing foreclosure

Chablis Arnolody feels like she’s in limbo. While she would love to retile her kitchen floor and perform some repair work on the walls of her home, she has no idea how much longer it will be hers.

Arnoldy and Christina Perryman met Monday with officials from the Bend office of U.S. Rep. Greg Walden, R-Ore.

But Arnoldy said she could be running out of time.

She’s getting phone calls from Bank of America asking for payments on her mortgage — payments she was told to stop making in order to be considered for a short sale.

When she explains her situation to the callers, Arnoldy said she can’t help feeling like she gets a different response from each one.

“It’s such a huge financial entity,” she said. “Sometimes it feels like one hand doesn’t know what the other is up to.”

Both she and Christina Perryman will likely face foreclosure if they can’t find a resolution.

While Perryman was excited to learn about the modification pilot program, she’s no longer optimistic it will let her stay in her home.

“I don’t think it’s going to happen,” she said.

As for Arnoldy, she can’t help but get mad that Bank of America is telling her she can’t short sale her home, because it would put her at an unfair advantage.

“Why do they get to decide whether it benefits me? This program would let me stay in my home,” Arnoldy said. The pilot program “is a direct relation to what has been happening in this community for the last three years.”