Home loans were repaid in August at a pace that would erase 25 percent of the debt in a year, according to Lender Processing Services Inc., a Jacksonville, Florida-based data provider that tracks 40 million mortgages.

The cost of 30-year loans dropped to 3.4 percent last week, helping push refinancing applications to a three-year high, after the Federal Reserve said it will buy $40 billion of mortgage securities per month to stimulate the economy. That followed government efforts to increase refinancing with new rules designed to expand eligibility and reduce costs.

“There should be a lot of opportunity for people to refinance,” Herb Blecher, senior vice president at LPS Applied Analytics said in an interview. “The interest rate environment is favorable even for folks who refinanced recently to get a new loan.”

Prepayment speeds also reflect borrower defaults and debt retired in home sales, which increased in August to a two-year high as the housing market showed signs of recovery.

Refinancing applications climbed almost 20 percent last week to the highest since April 2009, leaving this year’s average pace 56 percent greater than in 2011, according to a Mortgage Bankers Association index released today.

Repeat Refinancing

Borrowing costs for typical 30-year fixed-rate loans have declined from last year’s high of 5.05 percent, according to Freddie Mac surveys. That’s spurred a wave of repeat refinancing activity. Prepayment speeds in August rose the most among loans made last year, climbing 23 percent, LPS data show.

Mortgage bond investors monitor prepayment rates as they influence returns. Bondholders risk losses when buying debt for more than 100 cents on the dollar as the value can be erased when homeowners take out new mortgages too quickly to repay existing debt. With debt trading below face value, returns increase when repayments accelerate.

Prepayments on loans to underwater borrowers have risen the fastest this year, climbing 65 percent for homeowners who owe at least 20 percent more than their property value, according to LPS.

President Barack Obama’s administration has helped fuel gains in refinancing this year by making it easier for borrowers with Fannie Mae and Freddie Mac loans without home equity to qualify and by reducing costs for homeowners with older Federal Housing Administration loans.

Purchases of previously owned homes increased 7.8 percent in August to a 4.82 million annual rate, the most since May 2010, the National Association of Realtors said Sept. 19.