U.S. mortgage applications rose during the first week of 2010, reflecting a surge in demand for home refinancing loans as interest rates dropped, data from an industry group 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 said its seasonally adjusted index of mortgage applications, which includes both purchase and refinance loans, for the week ended January 8 increased 14.3 percent to 528.1. The index, however, pales in comparison to its year-earlier level of 1,324.8.

The four-week moving average of mortgage applications, which smoothes the volatile weekly figures, was down 6.4 percent.

The lowest mortgage rates in decades and high affordability helped the hard-hit U.S. housing market find some footing in 2009 after a three-year slump.

Anthony Hsieh, founder and CEO of loanDepot.com, a mortgage lender based in Irvine, California and currently licensed in 18 states, said tight lending standards are one of the sector's biggest obstacles right 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 seasonally adjusted index of refinancing applications increased 21.8 percent to 2,407.2.

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. The prior week's rate was the highest rate since late August.

Interest rates, however, were above the year-ago level of 4.89 percent and an all-time low of 4.61 percent set in the week ended March 27, 2009. The survey has been conducted weekly since 1990.

The refinance share of mortgage activity increased to 71.5 percent of total applications from 68.2 percent the previous week. The adjustable-rate mortgage, or ARM, share of activity was unchanged at 4.0 percent from the previous week.

Cameron Findlay, chief economist at LendingTree.com in Charlotte, North Carolina, said mortgage rates should rise sharply this year, 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 at the end of March stops buying mortgage-related securities. The Fed's agency MBS and agency debt purchase programs, aimed at lowering borrowing costs, will have reached more than $1.4 trillion.

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

Renowned Yale University economist Robert Shiller said on Tuesday he sees U.S. housing prices falling further in coming months, fueling more fears about the broader economy.

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.