Wells Fargo Home Mortgage says it’s discontinuing its subprime 2/28 and one-year adjustable-rate mortgages (ARMs) in response to new guidance from federal regulators and downgrades on subprime bonds by ratings agencies.

The 2/28 mortgage is an adjustable-rate mortgage on which the rate is fixed for two years and then reset to equal the value of a rate index at that time, plus a margin. Because the margins are high, the rate on most 2/28s will often rise sharply at the two-year mark, even if market rates do not change during the period, according to mortgage analyst Jack Guttentag. 

In a statement issued Monday, Wells Fargo said it “routinely assesses its loan products, terms and prices, and is changing how it offers select subprime products.”

Wells Fargo said that in its third-party subprime lending channel, the 1-year ARM, the 2/28 ARM and the 40/30 2-year ARM were discontinued July 18.

Wells Fargo’s retail business line stopped offering the 1-year ARM, the 2/28 ARM and the 40/30 2/6 LIBOR ARM on Friday, the company said.

“These changes are being made to align our practices with industry guidance, as well as appropriately respond to recent downgrades by key ratings agencies regarding subprime bonds,” the company said in a statement.

Countrywide Financial Corp., Washington Mutual Inc., First Franklin and Option One Mortgage have also announced they are discontinuing 2/28s, Reuters reported.

New guidance on subprime lending, finalized by federal regulators June 29, instructs banks and other lenders making 2/28s and other types of ARM loans to qualify borrowers at the fully indexed rate, and to make stated-income and reduced-documentation loans only in special cases.

In a response to rising delinquencies and defaults, ratings agencies have downgraded billions in bonds backed by subprime loans, which raises the cost of borrowing for lenders that sell their loans on the secondary market.

In reporting its second-quarter earnings on July 17, Wells Fargo said residential mortgage originations of $80 billion were essentially flat from last year. A $2.4 billion increase in prime originations was offset by a $1.4 billion decline in subprime originations, reflecting changes in underwriting guidelines that were made during the first quarter.

Wells Fargo said it originated no negatively amortizing loans, such as pay-option adjustable-rate mortgages, and held no subprime no- or low-documentation mortgages in its portfolio.

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