Mortgage rates fall to 4-month low
By Holden Lewis • Bankrate.com

The housing bust is hitting the mortgage market, too.

Rates on long-term mortgages have dropped to their lowest level since April this week as loan applications dried up. Fewer people are applying for home loans than at any time since May 2002, according to the Mortgage Bankers Association. The association's market composite index, a measure of loan application volume, is down 29 percent from a year ago.

The benchmark 30-year fixed-rate mortgage fell 12 basis points to 6.65 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.3 discount and origination points. One year ago, the mortgage index was 5.91 percent. Four weeks ago, it was 6.91 percent, and it was 6.89 percent two weeks ago.

The 15-year fixed-rate mortgage fell 9 basis points to 6.3 percent. The 5/1 adjustable-rate mortgage fell 11 basis points to 6.36 percent.

A number of factors contribute to the falling of rates. Lenders compete vigorously for slices of the shrinking pie. People all over the world buy U.S. Treasuries and mortgage-backed securities as safe investments during wartime, pushing down the yields of those financial instruments. The bond market awaits next week's Federal Reserve rate-policy meeting. The government reports that the economy slowed in the second quarter of the year.

Weekly national mortgage survey

Results of Bankrate.com's Aug. 2, 2006, weekly national survey of large lenders and the effect on monthly payments for a $165,000 loan:

Core PCE catches economists' eyes
Bond investors paid less attention to another part of the GDP report: a measure of inflation called the core personal consumption expenditures price index. If you want to impress an economist, just call it the core PCE index. It showed that prices for items, excluding food and energy, were up 2.4 percent from the second quarter of 2005. That's higher than the Fed wants inflation to be. What's worse, core PCE rose at an annual rate of 2.9 percent in the second quarter -- a sign that inflation was accelerating.

As an analogy, think of the economy as a car that's going down a 60-mile stretch of road in which there are checkpoints exactly every 15 miles. The Fed wants the car to take at least an hour to travel the 60 miles. The car passes the third checkpoint at the 45-minute mark, but clears the last 15 miles in just 10 minutes. Time to hit the flashing red lights.

The Fed's braking action
But the consensus on the bond market is that a slowing economy will bring inflation down eventually as the Fed's 17 consecutive rate increases take full effect. The Chicago Board of Trade has priced in a 64 percent chance that the Fed won't raise rates on Aug. 8. There's a 36 percent chance of a quarter-point increase.

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Whether rates go up or down, some portion of homeowners have reason to refinance. According to mortgage financing giant Freddie Mac, a big reason to refinance in the second quarter was to extract cash from the home's equity.

From April through June, 88 percent of Freddie Mac-owned loans that were refinanced resulted in new loans that were at least 5 percent higher than the old loan balances, according to Freddie. Those people were doing cash-out refinances.

Freddie Mac economist Amy Crews Cutts says a lot of people are using cash-out refinances to pay off the balances of their home equity lines of credit. That can result in lower monthly payments, because the average rate on a credit line is near the prime rate of 8.25 percent.