Mortgage applications rose 7.1% in the week ending July 29 with both purchase and refinancing activity higher.  

"Treasury rates plummeted more than 20 basis points last week as all eyes were focused on the debt ceiling negotiations in Washington, and economic data depicted much-slower-than-anticipated economic growth," said Michael Fratantoni, Mortgage Bankers Association (MBA) vice president of research and economics.

As a result, 30-year fixed mortgage rates declined to 4.45% from 4.57% with points dropping to 0.78 from 1.14 for 80% LTV loans. This is the lowest rates have been since November 5, 2010.  

In addition, 15-year fixed mortgages fell to a record low in the MBA's survey history of 3.52% from 3.67%.

The Refinance Index increased 7.8% to ~2784 – its highest level since around mid-June. Despite the gain and rates back below 4.50%, Fratantoni pointed out that "the refinance index is still almost 30% below last year's level.Factors such as negative equity and a weak job market continue to constrain borrowers."

MBS analysts say mortgage rates need to drop closer to 4% in order for refinancing activity to reach the 4000-5000 level seen last fall.  

Even then speeds are not expected to reach the 2010 peaks hit in November as a result of a lower level of moneyness as many borrowers previously refinanced, weaker response from Federal Housing Administration borrowers due to increased fees, burnout and Home Affordable Refinancing Program ineligibility, Credit Suisse analysts said.  

Looking at FNMA 4.5% and 5% 2008-2010 vintages, speeds are currently expected to prepay between 50% and 70% at last November's highs.

Meanwhile, the Purchase Index rose 5.1% to ~186. Still, purchase activity "remains weak by historical standards," Fratantoni said.

The MBA also reported that as a percent of total application activity, refinancing share rose to 70.1% from 69.6 percent. ARM share was also higher to 6.6 percent from 6.1% previously.

Sandler O'Neill & Partners in a note pointed out that the effective 30-year rate of 4.61% is now within 16 basis points of the all-time low set last October.

Effective 15-year rates have fallen to a new low (3.78% versus 3.88%), which, according to the Sandler O'Neill report, should spur an increase in refinancing activity by recent 15-year borrowers.

Higher-quality borrowers with relatively fresh documentation should be most eligible for refinance. 

"With mortgage rates dropping below 4.50%, we are moving closer to the point where many recent borrowers will be able to refinance for the first time," explained Scott Buchta, managing director at Sandler O'Neill, in the report. "Any subsequent pick-ups in the refinancing index will reflect activity in the 30-year 4.5% and 15-year 4.0% coupons."          

The report said that the refinancing index is likely to begin to climb upwards in the next one to two weeks as originators start to lower their offered rates and borrowers re-enter the market.

Jumbo, nonconforming pools of mortgages are more sensitive to smaller moves in mortgage rates and the upcoming reduction in loan limits from $729,500 to $625,000 can spark some added refinancing activity over the couple of months, Buchta said.

The reduction is scheduled to be effective Oct.1 and the government has recommended that the temporary caps not be extended further.

"In addition to the hard cap being reduced, the formula for calculating the local loan limits will also be reduced from 1.25x the median home price for an MSA to 1.15x," Buchta added. "This will results in a reduction of 10-15% in the conforming loan limit for many borrowers."

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