Wells Fargo Converts Option ARM’s to Interest Only

What is an Option ARM mortgage?

With an Option ARM, your monthly payment includes no principle payment and is actually less than the minimum amount of interest due. The difference in interest is then added to the outstanding loan balance, causing the overall loan balance to increase.

Repeat:  with this type of payment, each month your principal, or balance due, actually goes up.

Why would someone get this type of loan? Because the payments are low.  Artificially low.  But  paying the minimum payment each month is simply a way of deferring the interest, not avoiding it altogether.  Option ARMS are responsible for many borrowers now owning homes worth less than the mortgage debt.

Wells Fargo currently holds more than $107 billion in debt tied to option-adjustable rate mortgages and is reportedly converting these option arms into interest-only loans to avoid a complete disaster, according to the Wall Street Journal.

The company is issuing thousands of interest-only loans that will defer borrowers’ balances for as long as six to 10 years. Wells Fargo is wagering that an eventual rise in housing prices and a rise in consumer income will eventually cover the bank’s Pick-A-Pay debt. 

Wells Fargo has already written $2 billion off Pick-A-Pay balances for borrowers, or nearly $46,000 per modified loan.  Pick-A-Pay loans accounted for 10.8% of Wells Fargo’s average total loans in the third quarter.

Note: Wells Fargo never originated option ARM loans, but inherited them at a 20% discount when they took over Wachovia in 2008.  In return, Wells received a massive amount of tax breaks ($25 billion?) from TARP, according to the Washington Post.

So why not convert these to 30 year fixed mortgages rather than interest only? Because these borrowers used option ARMs for a reason – they could not afford a conventional mortgage and, chances are, they still can’t. Most can’t afford the full monthly payment that would start paying down the loan’s principal.

So, Wells Fargo is writing down the principal by an amount that can get these borrowers qualified for “interest only”. This will stop the loan balances from increasing, but still does not touch the principle amount.

This scenario is not much better than renting and may not give the borrower a reason to stay. With the home worth less than the mortgage balance, no or very little money of their own in the loan and seeing that they’re not paying it down anyway, what will prevent these borrowers from just walking away from the property and the huge debt?

Wells Fargo may simply be putting off their inevitable slide into more foreclosed properties.

Do you have an Option ARM?