NEW YORK - U.S. mortgage applications fell last week despite the lowest loan rates in four months, the Mortgage Bankers Association said on Wednesday, in another sign that housing will likely recover slowly from its three-year plunge.

Home loan applications fell a seasonally adjusted 2.8 percent in the September 25 week, driven down by a 6.2 percent drop in demand for purchase loans and a 0.8 percent decline in refinancing requests.

Borrowing costs inched closer to record lows, with average 30-year rates dipping 0.03 percentage point to 4.94 percent.

The 30-year rates were the lowest since the week ended May 22, at 4.81 percent, after hitting an all-time low of 4.61 percent in March, according to the industry group. A year ago, before intensive government interventions, 30-year rates averaged 6.33 percent.

For a related chart of mortgage rates, right click on the code: and select Related Graph.

Signs of life have emerged in both home sales and prices, helped by government stimulus programs including an $8,000 first-time home buyer tax credit.

The outlook for housing is split, however. Some in the industry predict another sales slide if the tax credit is not renewed and others say there will be a gradual recovery slowed by the usual winter sales malaise.

We're going to see another leg down, and if we lose the tax credit it will be a significant leg down, said John Burns, president of John Burns Real Estate Consulting in Irvine, California.

The main concern is shadow inventory, or the stockpiles of homes held by banks or those about to go into foreclosure but yet to be put on the market, he said.

The one really positive surprise recently has been falling mortgage rates, and rates at 5 percent or less next year could definitely help engineer a soft landing, said Burns.

Another concern is that the first-time buyer credit siphoned demand from next year's spring sales season, with buyers rushing purchases before the tax incentive disappears.

Existing-home sales in August fell for the first time in four months, but were at the second-highest pace in almost two years. Sales of new houses were below forecasts but up in August for the fifth straight month.

PRICES YET TO BOTTOM

Stuart Hoffman, chief economist at PNC Financial Services Group in Pittsburgh, does not expect another leg down in home sales but is not convinced that prices have hit bottom because of the large inventory of unsold homes.

Home prices rose in July for the third straight month, surpassing forecasts and bolstering the case for housing stability, based on the Standard & Poor's/Case-Shiller indexes reported on Tuesday.

I'd rather be a home buyer than a seller right now because I still think the odds are in your favor of getting a good deal, and the freefall in prices is over, Hoffman said.

But caution is advised with the pending demise of the tax credit, rising unemployment and the possibility of more foreclosures, S&P said.

Home prices on average have toppled by more than 32 percent from their peaks in the second quarter of 2006.

I would definitely characterize it as a slow recovery in housing out of a very deep hole, said Hoffman. We've gone from the sub-basement to the basement, and maybe we're going to get to the ground floor on housing by next spring. At least I think the process has begun.

(Editing by Leslie Adler)

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