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Refinances surged, mortgage rates dropped and a new government plan is likely to hold interest rates down.

The average 30-year fixed-rate mortgage tumbled 12 basis points from a week earlier to 5.04% in Freddie Mac’s survey of 125 thrifts, commercial banks and mortgage lenders for the week ending Feb. 19. Compared to the same week last year, the 30-year was 100 BPS lower.

The 15-year fixed-rate mortgage averaged 4.68 this week, 13 BPS lower than the prior week, Freddie reported.

The yield on the 10-year Treasury was 2.804% during trading today, unchanged from a week earlier.

Mortgage rates moved lower with bond yields as recent economic reports suggested the economy continues to slow — lowering the threat of inflation, Freddie’s Chief Economist Frank Nothaft explained in this week’s report. In addition, consumer sentiment fell to a three-decade low, January industrial production slowed more than expected and the Federal Reserve lowered its 2009 growth forecasts during its policy-setting meeting last month, “noting a deeper contraction in the economy as the credit crunch tightens.”

The Homeowner Affordability and Stability Plan announced yesterday by the Obama administration is likely to hold rates down for a while. In addition to committing capital to Freddie and its government-controlled rival Fannie Mae, the plan includes the Treasury’s continued investments in mortgage-backed securities issued by the two firms.

Bankrate.com said its panel of 100 mortgage brokers, mortgage bankers and other mortgage “experts” for the week Feb. 19 to Feb. 25 were mostly undecided about whether mortgage rates would move more than 2 BPS during the next 35 to 45 days. A decline was predicted by 46 of the panelists, while 36 saw no changes ahead and 18 expected an increase.

At 5.04%, the five-year Treasury-indexed adjustable-rate mortgage was no better than fixed rates but 19 BPS better than the previous week, the survey said.

Falling 14 BPS from seven days earlier, the one-year Treasury-indexed ARM averaged 4.80%, according to Freddie. The underlying index, the yield on the one-year Treasury, was 0.64% yesterday, 0.04% higher than seven days prior.

The six-month London Interbank Offered Rate, which is used as an index for many subprime ARMs, was 1.77% as of yesterday, Bankrate.com reported. LIBOR was 1.69% last week.

While ARM yields improved, ARM share didn’t. The Mortgage Bankers Association reported in its Feb. 13 Mortgage Applications Survey that ARM share fell to 2% from 3% the prior week.

Still, overall new loan applications jumped 46% on a seasonally adjusted basis in MBA’s latest survey, bringing the trade group’s Market Composite Index to 875.3. A 64% surge in refinance 1003s fueled the increase. Refinance share rose to 74% from 67% the previous week.

Refinance activity is likely to continue strengthening based on the Treasury’s intent to allow loans owned or guaranteed by Freddie and Fannie to be refinanced at loan-to-values of as much as 105% as part of the plan announced yesterday.

Purchase applications were 9% higher in MBA’s survey, and government applications — which primarily includes FHA activity — were just 6% higher.

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