The Mortgage Bankers Association said interest rates on fixed 30-year mortgage rates surged 12 basis points to average 3.90 percent in the week ended May 24. It was the highest level since May of last year and the biggest jump in 14 months.
The rise sent the seasonally adjusted index of mortgage application activity down 8.8 percent as refinancing applications tumbled 12.3 percent. It was the biggest drop in refinance applications this year as demand fell to the lowest level since December.
The refinance share of total mortgage activity decreased to 71 percent of applications from 74 percent the week before.
Still, the gauge of loan requests for home purchases, a leading indicator of home sales, rose 2.6 percent, suggesting potential homeowners may have sought to lock in a still-low rate.
Fed chairman Ben Bernanke said last week the Fed could scale back the pace of its bond purchases at one of the "next few meetings" if the economic recovery looked set to maintain forward momentum. The comments sowed concerns among investors that the Fed's ultra-loose policy could end sooner than expected.
Encouraging economic data last week also contributed to that view as home sales rose and durable goods orders improved.
"Rates rose in response to stronger economic data and an increasing chance that the Fed may soon begin to taper their asset purchases," Mike Fratantoni, MBA's vice president of research and economics, said in a statement.
The Fed is currently buying $85 billion a month in bonds and mortgage-backed securities as it seeks to keep borrowing rates low.
The low rates have helped the housing market, luring in buyers off the sidelines. The recovery in housing has been gaining traction since last year and data on Tuesday showed home prices saw their biggest annual increase in nearly seven years in March.
Rates had already been on the rise before Bernanke's comments and have gained 31 basis points since the start of the month.
The survey covers over 75 percent of U.S. retail residential mortgage applications, according to MBA.
(Reporting by Leah Schnurr; Editing by Diane Craft)