U.S. mortgage applications rose in the first week of 2010, reflecting surging demand for home refinancing loans as interest rates dropped, industry data showed on Wednesday.

Demand for loans to purchase a home, however, only rose marginally. A continuation of this trend would not bode well for the U.S. housing market, which has been showing signs of stabilization but remains highly vulnerable to setbacks.

The Mortgage Bankers Association (MBA) said its seasonally adjusted index of mortgage applications, including both purchase and refinance loans, rose 14.3 percent to 528.1 for the week of January 8. A year ago, the index was at 1,324.8.

The four-week moving average, which smooths out volatile weekly figures, was down 6.4 percent.

What makes the (applications) increase interesting is that nothing exceptional occurred to prompt people to return to the market, said Bob Walters, chief economist at Quicken Loans in Livonia, Michigan.

In fact, this may be indicative of the ebb and flow we can expect to see as the market continues to try and find its footing, he said.

The MBA said borrowing costs on 30-year fixed-rate mortgages, excluding fees, averaged 5.13 percent, down 0.05 percentage point from the previous week which was the highest rate since late August.

Interest rates were above the year-ago level of 4.89 percent and an all-time low of 4.61 percent set in March. The survey has been conducted weekly since 1990.

The lowest mortgage rates in decades and high affordability helped the market find some footing after a three-year slump.

Anthony Hsieh, founder and chief executive of loanDepot.com, a mortgage lender licensed in 18 states, said tight lending standards are one of the biggest obstacles now.

I have been in the mortgage business for the past 25 years, and I have never seen the industry as tight as it is today.

Once a borrower leaps over one hurdle in the loan application process they face yet another hurdle. So it is as if they are participating in some sort of triathlon, he said.

The MBA's seasonally adjusted purchase index, a tentative early indicator of home sales, rose 0.8 percent to 213.7. The index of refinancing applications increased 21.8 percent to 2,407.2.

The refinance share of mortgage activity increased to 71.5 percent of total applications from 68.2 percent.

Cameron Findlay, chief economist at LendingTree.com in Charlotte, North Carolina, said mortgage rates should rise sharply, reaching 6.20 percent in the fourth quarter.

A rate at or over 6 pct is above my tolerance level.

The housing market cannot afford to go beyond that level, and I am convinced the Fed will take action to bring rates back down if they do, he said.

Interest rates are expected to rise when the Federal Reserve stops at the end of March its purchase of mortgage-related securities, which is aimed at lowering borrowing costs.

U.S. residential mortgage originations will plunge 40 percent this year to the lowest in a decade as home refinancing demand sinks with rising mortgage rates, the MBA said in its annual forecast on Tuesday.

The MBA said fixed 15-year mortgage rates averaged 4.45 percent, down from 4.62 percent the previous week. Rates on one-year ARMs increased to 6.83 percent from 6.42 percent.