Mortgage interest rates are at their lowest levels since May, a reality that confounds common sense.

According to Freddie Mac, as of November 1st interest rates were down to 6.26 percent for 30-year, fixed-rate financing.

If you think the mortgage meltdown is a mess today, imagine if interest rates were at 7 percent, 8 percent or 9 percent? Nothing we've seen to date in terms of foreclosures, lender failures and investor losses would match the chaos which would ensue with higher rates. Even Wall Street would be unable to hide the damage with accounting tricks and Enron-like, off-the-books, entities.

It is an absolute miracle -- a financial miracle -- that the housing situation is not significantly worse than it is today. Look at interest rates for the past several decades and it's simply unreasonable to think that today's rates are anywhere near the middle of the scale. Truth is, we're looking at rates last seen in the 1960s.

Today's low interest rates raise some questions: If money is a commodity -- and it is -- then do not low rates suggest a large amount of mortgage money supply chasing a limited amount of mortgage money demand? And, if a lot of cash is available for mortgages, why is that given the headlines of the past few months?

There's an oddity here. News reports say investors are leaving the mortgage marketplace as quickly as possible, especially when subprime and ALT-A loans are involved. Doesn't that mean supply is drying up?

It sure sounds that way. But if the supply of mortgage funding is drying up then why is it that rates are so low?

One possible answer is that while supply is tightening, demand is falling at a faster pace. We know that existing home sales are down significantly. For example, the National Association of Realtors reports that existing home sales for September were down 19.1 percent when compared with a year earlier and that typical prices fell 4.1 percent during the same period.

That 19.1 percent is a huge number, especially in the context of such a short term.

Home sales, however, are not the only source of mortgage demand. There's also refinancing and additional financing, often in the form of home-equity lines of credit (HELOCs). The Mortgage Bankers Association reports that loan applications are up 19.5 percent when compared with a year ago. The survey "covers approximately 50 percent of all U.S. retail residential mortgage applications, and has been conducted weekly since 1990. Respondents include mortgage bankers, commercial banks and thrifts."

How can there be so many loan applications? One answer might be that a lot of loans are falling through and never making it to closing.

Even with refinancing and HELOCs it's difficult to imagine that loan demand -- except for FHA financing -- has remained stable, much less increased. If there's so much demand why are rates down? Falling home values in many communities mean it's often tough to refinance existing mortgages, especially those with negative amortization. Borrowers with such financing often lack the equity needed to get a new mortgage in an era when home loans with little or nothing down make responsible lenders nervous. Borrowers without cash or equity are effectively stuck with whatever financing they have, regardless of how awful.

The bottom line seems to be that while mortgage investors are leaving the marketplace borrowers are leaving at a faster pace. Or maybe it's not so much that they're leaving, rather they're being pushed out.

Many of the loans available even six months or year ago are now among the missing. These are largely "affordability" loans, a term for mortgages that routinely feature little or nothing down, negative amortization, the potential for enormous interest increases when loans reset, hefty prepayment penalties and -- inevitably -- high rates of foreclosure. Not only are a lot of these loans gone, so are some of the lenders who made them. Take a look at Aaron Krowne's Mortgage Implode-O-Meter for a savvy view of what's happening to lenders.

What about the Federal Reserve? In the past few weeks it has twice lowered the federal funds rate much to the initial joy of Wall Street. The problem is that the Federal Reserve impacts short-term rates, thus the Fed action may have value for those with home equity lines of credit but the Fed reductions will do little if anything for most mortgage borrowers.

No less significant is that a number of investors have begun to wonder if the Fed reductions will result in increased inflationary pressures. If that happens mortgage rates will soar as will many other expenses because it will take more paper dollars to buy goods. We're already seeing this with the price of oil and the value of the Canadian dollar. If you're an investor looking to buy mortgage-related paper you certainly wouldn't want fixed-rate loans in your portfolio if you thought inflation was on the horizon.

If interest rates increase then the entire housing stock will be impacted: Higher rates mean fewer borrowers will qualify for given levels of financing. With less buyer demand, home prices will fall.

Homeowners with ARMs will face steeper monthly costs -- plus less ability to sell. The result? More foreclosures and lower home values for everyone, including those who own homes which are mortgage free.

So, why such low mortgage interest rates? Why such low mortgage rates in the face of massive balance-of-payments debts, huge federal deficits, rising oil costs, turmoil on Wall Street and foreclosures down the block? The answer is unknown. Maybe in the future financial historians will be able to explain what we're seeing today.

For those who borrow today the warning signs are clear: Pay down debt and finance with fixed-rate mortgages. The alternative is to be at the mercy of the marketplace -- and the marketplace is not known for being particularly indulgent or forbearing when folks can't repay their debts.

For more articles by Peter G. Miller, please press here .