As expected, mortgage application activity declined last week as mortgage rates moved higher. The Mortgage Bankers Association reported that its Refinance Index was off 3% to 1863 while the Purchase Index fell 6% to 438. Despite the decline in the Refinance Index, activity remains relatively strong considering the level of rates. For example, last June 2004, when mortgage rates were at similar levels, the Refinance Index was around the 1400 area.

In a recent report, UBS analysts said one reason is the proliferation of option ARM products offering attractive teaser rates with low minimum monthly payments. Countrywide Securities analysts also report that origination in conforming balance fixed rate I/O loans has grown "to significant proportions" in the past few months. For example, at the start of this year, Countrywide's fixed rate I/O production as a percentage of total conforming fixed rate mortgages was around 1%. Currently, it is running at over 6%, and analysts believe the percentage could readily represent 10% or more of fixed rate production by mid next year.

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