Applications for U.S. home mortgages increased last week as both home purchases and refinancing picked up, an industry group said Wednesday.

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity rose 3.2 percent to 631.1 in the week ended Jan. 26 after dropping 8.4 percent the previous week and 0.6 percent two weeks ago.

The upturn comes after last week's December reports on U.S. new and existing home sales showed signs of improvement, although home sales for all of 2006 posted the biggest annual drop in more than 15 years.

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Inventories of unsold homes shrank in December, however, a first step toward returning to more "normalized" levels. A huge swell in homes lingered unsold on the market last year after five years of record home price gains squeezed affordability.

"Clearly there are a few really strong trends right now that are helping the market, and, more importantly, the consumer," said Robert Foregger, chief strategy officer at EverBank in Stowe, Vermont.

"Unemployment remains at record lows ... consumer confidence is way up," he added. "You see some nice pick-up on the consumer side. It could have been a lot worse" for housing if the job market was weaker.

Employment is a driver of home ownership, and any souring could mean the difference between a housing sector that pushes ahead or faces a more severe correction, several analysts said.

The January reading on U.S. job creation will be reported on Friday by the U.S. Labor Department.

The MBA's seasonally adjusted purchase index advanced 1.3 percent to 408.0, still 6.4 percent below its year-ago level. That index is considered a timely reading on home sales.

The group's seasonally adjusted refinancing application index grew 4.9 percent to 1,940.2, sending it 11 percent higher than a year earlier.

Four-week moving averages of these three readings, which smooth volatile weekly readings, were up 2.2 percent for the market index, 0.1 percent for the purchase index and 4.0 percent for the refinance index, according to the MBA.

Borrowing costs on 30-year fixed-rate mortgages, excluding fees, rose 0.07 percentage point to average 6.29 percent, according to the MBA. The contract rate was up just slightly from 6.20 percent a year earlier.

DISARMING

The refinance share of applications slipped to 47.4 percent from 47.8 percent a week earlier.

The share of adjustable-rate mortgages climbed to 21.4 percent from 20.3 percent. While fixed mortgage rates rose, adjustable loan rates headed lower. Rates on one-year ARMS, for example, dipped to 5.86 percent from 5.91 percent.

Much of the refinancing is by borrowers with ARMs that face adjustments to much higher loan rates.

"The big trend by far in the world of refinancing is people who are disarming," said Bob Walters, chief economist at Quicken Loans, a mortgage lending company based in Livonia, Michigan.

The MBA has estimated that $1.1 trillion to $1.5 trillion of ARMs are eligible to be reset this year. Some $600 billion to $700 billion of them will likely refinance into various loan products, including fixed-rate mortgages, while $500 billion to $800 billion will reset, according to the trade group.

"It's almost a no-brainer," Walters said.

"Anyone who took an ARM in the last three, four or five years won big. Not only did they save a tremendous amount of money by taking advantage of when the Federal Reserve went down to 1 percent (on short-term interest rates), they're also able now to exit those ARMs into historically low long-term rates."

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

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