U.S. consumer demand for home mortgage loan applications fell last week to the lowest level this year despite a marked drop in interest rates, as industry trade group said Wednesday.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity for the week ended March 17 decreased 1.6 percent to 565.0 from the previous week's 574.4, its lowest level of 2006.

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"It is very evident that the steam is coming out of the housing market even though rates moved down," said Celia Chen, director of housing economics at Moody's Economy.com, a consulting firm.

Borrowing costs on 30-year fixed-rate mortgages, excluding fees, averaged 6.31 percent, down 0.11 percentage point from the previous week's 6.42 percent level, a near four-year peak.

Fixed 15-year mortgage rates averaged 5.99 percent, down from 6.06 percent the previous week. Rates on one-year adjustable-rate mortgages (ARMs) increased to 5.68 percent from 5.64 percent.

"A lot of consumers have been having affordability problems, which is why a lot of them have been taking out ARMs," said Chen. "But with ARM rates rising, fewer people have been able to afford a home, which was also behind last week's decline in applications."

The MBA's seasonally adjusted purchase mortgage index

— considered a timely gauge of U.S. home sales — dropped 2.3 percent to 393.6 from the previous week's 403.0. The index was only a few points above its two-year low of 391.7 reached during the week ended Feb. 10. The index was also significantly below its year-ago level of 446.4.

The group's seasonally adjusted index of refinancing applications decreased 0.6 percent to 1,574.5 compared to 1,583.6 the previous week. A year earlier the index stood at 1,894.4.

With rates on ARMs rising last week demand for floating-rate products dropped, Chen said.

The ARM share of activity fell to 28.3 percent of total applications from 28.8 percent the previous week. ARM demand reached a 2005 high of 36.6 percent in late March.

Refinancings increased as a percentage of all mortgage applications, rising to 38.1 percent from 37.7 percent, the MBA said.

Bob Walters, chief economist at Quicken Loans, an online mortgage lender, said the only difference between long- and short-term rates is that short-dated rates seem poised to rise again as a result of next week's FOMC meeting.

"That red flag should continue to spur refinance activity among consumers in adjustable rate mortgages," he said.

OTHER SIGNS POINT TO COOLING

Historically low mortgage rates have fueled a five-year housing boom, helping support the U.S. economy's recovery from recession despite uncertain business investment.

Despite last week's rate drop, most analysts say that mortgage rates are on the rise. While they may differ on whether or not there is a housing bubble, most agree that the market is now cooling off from its record run.

In comments made to investors on Monday, Federal Reserve Chairman Ben Bernanke said growth in the housing sector was slowing, but not at a rapid enough rate to derail growth in the U.S. economy.

More insight into the state of the U.S. housing market will emerge on Thursday when the National Association of Realtors releases data on February existing home sales. The Commerce Department releases February new home sales data on Friday.

The MBA's survey covers about 50 percent of all U.S. retail residential mortgage originations. Respondents include mortgage bankers, commercial banks and thrifts.

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