Freddie Mac reported a sharp decline in both fixed and adjustable mortgage rates this week.

The 30- and 15-year fixed mortgage rates fell 28 basis points to 5.19% and 4.92%, respectively.

Freddie Mac Chief Economist Frank Nothaft said that 30-year fixed mortgage rate levels are at their lowest since the survey began in 1971.

Adjustable mortgage rates were down 22 basis points on five-year hybrid ARM rates to 5.60%, while one-year ARMs averaged 4.94% compared to 5.09% last week.

The historic low on the 30-year fixed mortgage rate should encourage mortgage application activity this week. Yesterday, the Mortgage Bankers Association (MBA) announced that the Refinance Index jumped 10.3% to 4156 in the week ending Dec.12 in response to the modest decline in mortgage rates last week.

The MBA currently forecasts 30-year fixed mortgage rates to average 5.3% in the first half of 2009 related to the economic contraction, and 5.4% in the second half as the economy starts to rebound. In 2010, the association is expecting that mortgage rates will average 5.5%.

The prospect of declining mortgage rates could have a significant impact on prepayment speeds, particularly if refinancing activity picks up. This will be seen primarily if the GSEs remove the reappraisal requirement on refinanced loans and reduce the g-fees. Also influencing speeds will be loan modification programs. Bank of America (BofA) analysts believe that as more loans are modified in 2009, they will be pulled from existing pools.

BofA's baseline projection for one-year prepayment speeds on FNMA 30-year MBS is 10-14 CPR on 5s, with the less seasoned prepaying on the higher end of the range. If rates decline 50 basis points, they expect one-year speeds of 15 CPR and 25 CPR at negative 100 basis points and 5.5s are projected at 14 to 15 CPR in the base case, increasing to 21 CPR at negative 50 basis points and 35 CPR at negative 100.

Finally, one-year CPRs on 6s are projected at 15-18 CPR in the baseline case, around 30 CPR at negative 50 basis points and 40 to 45 CPR in the negative 100 basis point scenario. While speeds are expected to pick up substantially, analysts do not believe they will reach the extreme levels seen in the refinance waves before the credit crisis because of the ongoing decline in home prices.

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