Dec. 17 (Bloomberg) -- Mortgage applications in the U.S. increased 2.9 percent last week as more homeowners refinanced to take advantage of lower interest rates.

The Mortgage Bankers Association’s index of applications to buy a home or refinance a loan rose to 841.4 from a revised 817.7 a week earlier. The group’s refinancing index increased 6.5 percent, while the purchase gauge dropped 4.5 percent.

Declining mortgage rates, brought on by Federal Reserve actions to purchase mortgage-backed debt, are making it more attractive for existing loan holders to refinance. Even so, the faltering economy continues to discourage home purchases.

“Sales have pretty much flattened out all year,” Richard DeKaser, senior economist at National City Corp. in Cleveland, said before the report. “It’s still a bad market. A broader- based rebound remains far in the future.”

The refinancing gauge rose to 4156 from 3901.9 the prior week, while the purchase index fell to 286.1 from 299.6.

The Fed yesterday cut its target federal funds rate to a range of zero percent to 0.25 percent and said it will do whatever is necessary to ease the recession.

“Weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time,” the Federal Open Market Committee said in a statement.

Fed’s Debt Purchases

The Fed’s plan to purchase up to $500 billion in so-called agency debt as well as up to $100 billion in direct debt of Fannie Mae and Freddie Mac and the Federal Home Loan Banks has sent mortgage rates tumbling. The average rate on a 30-year fixed-rate loan fell to 5.18 percent last week, the lowest in more than five years, from 5.44 percent a week earlier.

At the current rate, monthly borrowing costs for each $100,000 of a loan would be about $547.88.

The share of homeowners seeking to refinance increased to 76.9 percent last week from 74.3 percent.

Today’s report also showed the average rate on a 15-year fixed mortgage decreased to 4.93 percent, from 5.08 percent a week earlier. The rate on a one-year adjustable loan dipped to 6.63 percent from 6.76 percent.

U.S. foreclosure filings in November were 28 percent higher than a year earlier and a brewing “storm” of new defaults and job losses may force 1 million homeowners from their properties next year, RealtyTrac Inc. said Dec. 11.

Builders are responding to the reduced sales and higher inventory or unsold homes by cutting back construction. Housing starts in November fell to a record-low annual rate of 625,000, the Commerce Department said yesterday. Building permits, a sign of future construction, also decreased to an all-time low.

Toll Brothers Inc., the largest U.S. luxury homebuilder, last week reported its worst annual results since going public more than 20 years ago. The company also said revenue in fiscal 2009 will be “significantly” below the previous year and that it may deliver only 2,000 to 3,000 homes for the period, compared with 4,743 homes this year.

The Washington-based Mortgage Bankers Association’s loan survey, compiled every week since 1990, covers about half of all U.S. retail residential mortgage originations.

To contact the reporter on this story: Courtney Schlisserman in Washington cschlisserma@bloomberg.net

Last Updated: December 17, 2008 07:00 EST