The decline owes primarily to last week's announcement that the Federal Reserve would continue its massive economic stimulus program. Although economists still believe rates will climb over the next year, buyers may now enjoy some breathing room in the wake of sharp home price increases.
The weekly rate report from home finance giant Freddie Mac comes on the heels of recent data showing housing markets in Southern California and nationally have cooled some after months of sharp increases.
The survey, which asks lenders about the terms they are offering to solid borrowers, showed the 30-year fixed-rate mortgage averaging 4.32%, down from 4.5% a week earlier. It was the lowest rate in nine weeks, Freddie Mac said, though still about a percentage point above where it bottomed out in May.
Lenders were offering 15-year fixed mortgages to solid borrowers at 3.37% early this week, down from 3.54% last week. Initial rates for variable mortgages fell as well, Freddie Mac said.
The Fed announced last week that the economy was still not strong enough to allow the central bank to slow down its purchases of Treasury and mortgage-backed bonds. The effect of the massive stimulus is to push down interest rates, juicing the economy with cheap money.
The latest economic reports, such as consumer confidence, remain "tepid," explaining the Fed's decision, said Paul Habibi, a real estate lecturer at UCLA's business and law schools.
"Many believe that tapering is still several months away," Habibi said. "The Fed will need to see a string of positive data before changing its stance."
Rates shot sharply higher this summer when the bond and housing markets became convinced that the Fed would start backing off its bond purchases in September. For a time, home prices continued to shoot higher as well, leaving would-be buyers with their heads swimming.
The double-digit growth in home prices nationally continued in July, with prices up almost 25% year over year in San Francisco and about 20% in the Los Angeles and San Diego regions, according to the widely watched Standard & Poors/Case-Shiller index.
But S&P officials said the price run-ups appear to be easing, a welcome shift for first-time home buyers who were being priced out of more expensive markets.
Habibi said he believes price gains will moderate, predicting increases in the 6% to 8% range over the next 12 months.
The reason is that more homes will be on the market: Homeowners regaining equity they lost during the housing crash will list their properties, spilling "pent up supply" into the market.
Home builders are also expected to boost production.
While the refinance boom has largely dried up, the current rates are low enough to provide a benefit to some people who missed the chance to trade higher-interest mortgages for loans in the mid-3% range, said Stewart Larsen, head of mortgage lending at San Francisco's Bank of the West.
"There are a surprising number" of people who still have fixed-rate loans above 6%, Larsen said. "We think we've refi-ed the entire nation, but we haven't."
Current fixed rates are still low, and the consensus of economists is that they will rise, Larsen said.
"I think people got a little caught up in having the lowest rate to brag about at cocktail parties, when 4 1/2% is not a bad rate historically."
Still, Bank of the West has seen a marked increase in borrowers choosing adjustable-rate loans because their start rates are still lower.
These variable-rate loans are simple compared with the boom-era products that allowed borrowers to pay so little that their loan balances went up instead of down, he said.
The current ARMs offer fixed rates for three, five or seven years before they become variable, making it relatively simple for borrowers to weigh benefit against risk, Larsen said.
"It's a personal choice," he said. "You have to decide if you'll be out of the house before the rate adjusts, or be sure you can handle the payment when it does."
About 1 in 3 borrowers is now getting an adjustable-rate loan at Bank of the West, compared with 1 in 6 before rates rose, he said.