Potential home buyers attend an open house in the Seattle, Washington.

Brief drop in mortgage rates fuels refinancing activity  Wednesday, 5 Oct 2016 | 7:32 AM ET | 01:20

Fears in the European banking community last week created something of a tantrum in U.S. bond markets, driving yields down and taking mortgage rates along with them.

As a result, mortgage application volume rose 2.9 percent on seasonally adjusted basis for the week from the previous week, according to the Mortgage Bankers Association.

The volume gains were driven entirely by applications to refinance home loans, which rose 5 percent from the previous week, seasonally adjusted. Refinances are highly rate-sensitive, and even though rates have been hovering near record lows for months, the drop last week was clearly enough to get some borrowers off the fence and into a new loan.

Prospective home buyers view a kitchen while touring a model home at a PulteGroup housing development in Albuquerque, New Mexico.

Sergio Flores | Bloomberg | Getty Images
Prospective home buyers view a kitchen while touring a model home at a PulteGroup housing development in Albuquerque, New Mexico.

The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($417,000 or less) decreased to 3.62 percent, the lowest level since July, from 3.66 percent, with points decreasing to 0.32 from 0.33 (including the origination fee) for 80 percent loan-to-value ratio loans.

However, mortgage applications to purchase a home stalled, falling 0.1 percent for the week and dropping 14 percent from a year ago. That annual drop may have less to do with homebuying demand and more to do with new mortgage rules that went into effect a year ago.

“The mortgage industry is celebrating the one year anniversary of the TRID/KBYO regulatory implementation date this week,” said Michael Fratantoni, chief economist for the MBA. “Purchase application volume last week was almost 14 percent below the same week a year ago. That was the last week for mortgage applications to be covered by the prior disclosure regulations and as a result there was a spike in application activity.”

New regulations aside, homebuying has weakened due to the severe lack of homes for sale. An index measuring signed contracts for home sales fell in August for the third straight month, according to the National Association of Realtors. Tight supply is also pushing home prices higher faster and sidelining some buyers.

Affordability may weaken in coming months, as mortgage rates now seem poised to move higher. The average rate on the 30-year fixed mortgage jumped Tuesday on fears that the European Central Bank would taper its bond buying, which would trickle out to U.S. bond yields and the mortgage rates that follow those yields.

“It’s enough to bring the most prevalent conventional 30-year fixed quote back up to 3.5 percent (from 3.375 percent) on top tier scenarios. While that might now sound like a lot in and of itself, the risk is that it’s the beginning of bigger move that could take months to fully play out,” said Matthew Graham, chief operating officer of Mortgage News Daily.