NEW YORK - Demand for U.S. home loans fell last week to the lowest level in almost two months even though mortgage rates held steady below 5 percent, the Mortgage Bankers Association said on Wednesday.

Despite surprisingly robust November home sales, weak labor markets and looming sales of foreclosed properties suggest a long road to a sustained housing recovery, economists agree.

The industry group's mortgage applications index slid 10.7 percent in the week ended Dec. 18 to a seasonally adjusted 595.8, the lowest level since the week ended Oct. 23.

An index of demand for refinance loans dropped 10.1 percent and requests for loans to buy homes fell 11.6 percent last week.

Affordability is high, prices are low and going lower, rates are low, there are incentives in play and that all helps, said Mike Schenk, senior economist for the Credit Union National Association in Madison, Wisconsin.

The slack labor market, high consumer debt levels and home prices that are falling in many areas convince us that this will be a longer-term recovery than most people might be expecting.

Schenk said that along with the 10 percent of the workforce that is unemployed, 9.5 million people are underemployed and many others have dropped out of the labor force altogether.

Rising home sales are a hopeful sign, he added. But I don't think this is a signal that we have now begun to experience fundamental changes that will cause the housing market to resume its upward trajectory.

Borrowers continue to favor refinancing over purchasing, with more than three of every four applications a request to refinance.

Sales of existing homes shot up to a nearly three-year high last month and home price declines slowed in November, the National Association of Realtors reported on Tuesday. To see story, click on [ID:nN22392364].

Housing may have started turning a corner after its deepest crash since the Great Depression, thanks mainly to government actions to keep loan rates low and provide buyer tax credits.

Long-term borrowing costs were unchanged with the average 30-year rate holding at 4.92 percent last week. The rate has been as low as 4.61 percent in March, but had hovered above 6 percent before the Fed intervened.

When we start getting above 6 percent that may cool things down, but traditionally mortgage rates around 7 percent are thought to be normal, said Craig Thomas, senior economist at PNC Financial Services Group in Pittsburgh. We are so far below average that mortgage rates are the least of our worries.

Chief among those worries are unemployment, underemployment and wage cuts that are keeping many homeowners from paying loans on time.

Government pressure is escalating for banks to modify home loans for struggling borrowers. But the fixes often fail. To read more on serious delinquencies, see [ID:nN21247638].

WHAT LURKS IN THE SHADOWS?

The amount of distressed properties that have yet to hit the market, and the pace at which they will be sold, are seen as critical for assessing the health of U.S. housing.

Estimates vary widely and are hard to gauge while efforts are ramping up to avoid foreclosures through loan modifications and short sales.

Although housing and REO inventories are declining, mortgage defaults are continuing to increase, mortgage cure rates remain low and loans are taking a longer time to liquidate, said Shaun Ahmad, president of capital markets at RoundPoint Financial Group in Charlotte, North Carolina

REO inventories are properties that have been taken over by banks when loans fail. Inventories are shrinking while mortgage terms are being altered, but it remains to be seen how many of these modifications stick or turn into foreclosures.

RoundPoint estimates as many as 7 million distressed properties could come on to the market.

Even if it comes out in a controlled manner it's going to be difficult to digest and to achieve a sustained recovery, said Ahmad. Until that shadow inventory is addressed we really haven't solved the problem.

The Mortgage Bankers Association said its offices will be closed all next week and as a result it will release two weekly applications surveys on Jan 6.

Mortgage