Rates jumped to the highest level since July 2011, which also cut into refinance activity. The share of refinance applications fell to the lowest level in more than two years.
Interest rates on fixed 30-year mortgage surged 12 basis points to average 4.58 percent in the week ended June 28, the Mortgage Bankers Association said.
"At these rates, many fewer homeowners have an incentive to refinance," Mike Fratantoni, MBA's vice president of research and economics, said in a statement.
"Purchase application volume also declined, but not nearly to the same extent, as affordability remains strong."
Rates have been rising since early May, with the increase accelerated by comments from Fed Chairman Ben Bernanke last month that the central bank expects to wind down the pace of its quantitative easing program later this year if the economy improves as expected.
The Fed has been buying $85 billion a month in bonds and mortgage-backed assets to keep borrowing costs low and stimulate economic growth. The historically low mortgage rates have helped lure in buyers as the housing market gets back on its feet.
The recent higher cost of mortgages has raised concerns that the increase could dampen demand and slow the housing recovery, though most economists do not expect it to be derailed completely. Even with the increase, rates remain historically low.
While the rise in rates had appeared to cause some potential buyers to get into the market earlier in June, MBA's seasonally adjusted index of loan requests for home purchases decreased 3.1 percent last week.
Refinancing activity was hit much harder and the index tumbled 15.6 percent last week. The refinance share of total mortgage activity slumped to 64 percent of applications from 67 percent the week before. It was the lowest level since May 2011.
The overall index of mortgage application activity, which includes both refinancing and home purchase demand, slid 11.7 percent.
The survey covers over 75 percent of U.S. retail residential mortgage applications, according to MBA.
(Reporting by Leah Schnurr)