As adjustable rates soar, mortgage applications sink

The interest rate charged for one-year adjustable loans jumped last week by the most since the Mortgage Bankers Association began keeping records in 1996.

The report demonstrates the difficulty some homebuyers face in securing affordable financing. The organization's mortgage applications index fell 4 percent last week. The group's purchase and refinancing gauges each decreased for a second week.

Banks, forced to hold loans rather than resell them as securities because demand has dried up, are charging higher rates for riskier mortgages. The housing slump will worsen as banks restrict the availability of credit and falling real-estate prices prevent owners from tapping home equity for extra spending money, economists said.

"If rates go up and credit gets tighter, that is going to lead to a drop in demand on top of what we have already seen," said Abiel Reinhart, an economist at JPMorgan Chase. "That is going to have an adverse impact" on the economy through the first half of 2008, he said.

The mortgage bankers' purchase index fell 4 percent. The refinancing index decreased 4.2 percent. Both measures were the lowest in four weeks and below their year-earlier levels.

More than 100 lenders have ceased operations or sought buyers this year amid rising defaults on subprime loans.

Edward Hyman, chairman of International Strategy and Investment Group in New York, said today that a mortgage-market survey conducted by his firm showed conditions are "pretty bad" and "among the lowest ratings we have ever gotten."

The average rate on a one-year adjustable mortgage surged to 6.51 percent, the highest since January 2001, from 5.84 percent the prior week. The rate also surpassed the cost of a 30-year fixed loan for the first time.

The number of applications for adjustable-rate loans slumped 23 percent, while those for fixed-rate mortgages rose 0.2 percent. Adjustable-rate mortgages dropped to 15 percent of all applications, the fewest since July 2003.

Banks "are being very cautious in the volume of prime adjustables they are putting on their balance sheets," Douglas Duncan, the mortgage bankers group's chief economist, said in an interview. "The growth path for the economy has slowed significantly."

The average rate on a 30-year fixed loan fell to 6.41 percent last week, from 6.49 percent. At that rate, monthly borrowing costs for each $100,000 of a loan would have been about $626, little changed from a year ago.

The average rate on a 15-year fixed mortgage dropped to 6.1 percent from 6.2 percent the prior week.

The Mortgage Bankers Association's loan survey, compiled every week since 1990, covers about half of all U.S. retail residential mortgage originations.

Credit restrictions and a deterioration in financial market conditions "appreciably" increased the risks to economic growth, the Federal Reserve said Aug. 17 when it lowered the rate at which it lends to banks.

Fed officials had underestimated the contagion from subprime credit markets to less risky borrowers, some economists said yesterday following the release of minutes of the central bank's Aug. 7 meeting.

Policymakers forecast housing would restrain growth "for some time" and developments in mortgage markets suggested "the adjustment in the housing sector could well prove to be both deeper and more prolonged than had seemed likely earlier this year," according to the minutes.

Still, central bankers put aside concerns about the rising cost of funds because they weren't convinced that a slowdown in inflation would last. They maintained that inflation remained the most significant policy risk, and kept the benchmark interest rate target unchanged at 5.25 percent.

Since then, reports paint a more distressing picture for some lenders. Title insurer LandAmerica Financial Group said Tuesday it will cut 1,100 jobs in the second half of 2007 to reduce costs as mortgage originations decline.

The company is looking at increasing operating efficiencies "in these difficult times," said Chief Executive Officer Theodore Chandler Jr.

Home prices fell 3.2 percent in the second quarter from a year earlier, according to a report yesterday by S&P/Case-Shiller. It was the biggest decline since records began in 1987.

Bloomberg News reporters Carol Massar and Monica Bertran in New York contributed to this report.