Yesterday I showed where Bank of America (NYSE: BAC) was falling behind every one of its peers. Today, I want to show where it's smarter than others in the business.

On Wednesday, B of A said it'll begin cutting the principal mortgage balance of homeowners who are both delinquent and seriously underwater -- meaning their home is worth less than the mortgage. Hands down, this the smartest move it's made since letting former CEO Ken Lewis retire early.

Until now, mortgage modifications have been almost entirely based around reducing monthly mortgage payments without much regard to the loan balance. Through last September, a Treasury report shows just 13% of modifications cut principal. Many modifications actually increased principal by tacking late payments and fees back on to the existing balance.

But that does little to prevent foreclosures. One of the chief reasons mortgage delinquencies are so high is because homeowners are underwater. Once a home becomes a net liability rather than an asset, plenty of homeowners just call it quits and stop paying. In his book The Big Short, author Michael Lewis describes this better than anyone: A house without equity is just a rental with debt.

With principal-reducing modifications, B of A is finally taking on this problem -- which studies shows accounts for as much as 35% of all defaults -- in a meaningful way. And by doing so I can almost guarantee it'll end up finding a cost-effective solution to getting the housing monkey off its back. One sentence from the president of B of A Home Loans really sums it up: "Severely under-water homeowners are reluctant to accept a solution that does not offer some reduction in principal." So start cutting principal, and you'll dramatically reduce the redefault rate of modifications.

Other banks, particularly Wells Fargo (NYSE: WFC), and Citigroup (NYSE: C), have tested principal reductions as well. With B of A now in the mix, the remaining big bank -- JPMorgan Chase (NYSE: JPM) -- can't be too far behind. I'm really confident this will work, and hopefully become the norm in the mortgage modification world.

Fingers crossed.                                                                

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.