Prospective home buyers arrive with a realtor to a house for sale in Dunlap, Illinois. Daniel Acker | Bloomberg | Getty Images

December may be a slow month traditionally for the housing market, but mortgage lenders are suddenly getting busier. A sharp drop in interest rates drove mortgage application volume up 1.6 percent last week from the previous week, according to the Mortgage Bankers Association's seasonally adjusted index. Volume was 16 percent lower than a year ago. The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($453,100 or less) decreased to 4.96 percent, the lowest level since September, from 5.08 percent, with points increasing to 0.48 from 0.44 (including the origination fee) for loans with 20 percent down payments. The rate drop was the largest single-week decline in over a year.

"Mortgage rates fell across the board last week, driven by a similar slide in Treasury. Trade fears dominated investors' concerns for another week, and this was amplified by data released by the U.S. Commerce Department showing a widening trade deficit," said Joel Kan, MBA's associate vice president of economic and industry forecasting. Mortgage applications to purchase a home drove much of the volume, rising 3 percent for the week and 4 percent from a year ago. Buyers are usually scarce in December, when the supply of homes for sale is lean and the idea of moving in winter is not particularly appealing in much of the nation. But this year may be an outlier, because more supply is coming on the market and buyers who were priced out last spring amid heavy competition are now seeing an opportunity Mortgage applications to refinance a home loan increased 2 percent last week but were still 34 percent lower than a year ago, when interest rates were 72 basis points lower. Rates have fallen 21 basis points in the past two weeks, and while refinances are highly sensitive to weekly rate moves, millions of borrowers have already refinanced to record-low interest rates in the past few years, so the pool of potential refinancers is relatively small.