New mortgages to slide through 2007Housing market 'normalizing' after unsustainable, record five-year home sales, according to the Mortgage Bankers Association.October 25 2006: 5:03 PM EDT

CHICAGO (Reuters) -- The production of U.S. home loans will slide 19 percent this year to $2.46 trillion, the fifth-highest year on record, then drop another 14 percent in 2007 before stabilizing the next year, the Mortgage Bankers Association said on Tuesday.

The U.S. housing market is "normalizing" after record five-year home sales and a price surge that was unsustainable, MBA chief economist Doug Duncan told reporters at the MBA's 93rd annual convention.

Mortgage loan creation was at least $3 trillion in each of the past three years, reaching an all-time high of $3.9 trillion in 2003.

The "normalizing" is sure to impact the revenues of such residential home builders as KB Homes (Charts), DR Horton Inc. (Charts) and Lennar Corp (Charts).

Mortgage creation should drop to $2.12 trillion in 2007 and hold at that level in 2008, with rates on 30-year fixed-rate loans rising "modestly" in that time to 6.8 percent from just below 6.4 percent now, the trade group said.

Economic growth will keep slowing through the rest of this year but should return "'to near normal growth' during 2007 and 2008," the MBA said.

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Short-term mortgage rates jumped after the Federal Reserve hiked interest rates 17 times by a quarter-point each time since June 2004. The rising rates and several years of double-digit price surges crimped home affordability and dashed incentive for the home refinancings that were driving loan production.

"Long-term interest rates have remained low in the face of rising short-term rates, equity prices have risen nearly 20 percent, capital expenditures remain strong, the trade sector has turned from a big drag on growth to a modest stimulus and energy prices have dropped sharply," Duncan said of his forecast for longer-term stability.

The Fed likely will keep interest rates unchanged with the federal funds rate at 5.25 percent rate through 2008, the trade group predicts.

Arms length

The difference between fixed and adjustable loan rates is at its skimpiest in more than five years, decreasing the incentive for borrowers to take out adjustable-rate mortgages (ARMs).

The share of ARMs - which have been a huge driver of loan origination, particularly as borrowers sought to get into costlier or bigger homes - has been sliding and should continue to decline, the MBA said.

ARMs' share should drop to 19 percent of total loans by the end of 2008 from about 30 percent at the beginning of this year.

Some $1.1 trillion to $1.5 trillion of ARMs will be eligible to reset next year, the MBA estimated. How those loans play out could have a significant impact on the housing and mortgage debt markets.

Some $600 billion to $700 billion of those loans will likely refinance into various loan products, including fixed rate loans, while $500 billion to $800 billion will reset.

Delinquencies and foreclosures will rise along with homeowner mortgage payments, though MBA is not forecasting levels.

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