Mortgage markets worsened last week on renewed optimism in the european economy, more evidence of a U.S. economic recovery, and ongoing strength in housing.

The action sparked a stock market rally at the expense of mortgage bonds, sending conforming and FHA mortgage rates meaningfully higher for the first time in more than 2 months.

As reported by Freddie Mac’s weekly mortgage rate survey, the average 30-year fixed rate mortgage fell to 3.91 percent last week nationwide, with an accompanying 0.7 discount points plus closing costs. 1 discount point is equal to 1 percent of your loan size such that 1 discount point on a $100,000 loan is equal to $1,000.

But, let’s be honest. Most people don’t want to pay points, or it doesn’t make sense to pay the higher fees. Thus,  you may not find Freddie Mac’s survey altogether too useful anyway. This is because Freddie Mac’s reporting banks assume homeowners from California to Virginia want to pay discount points.

Most people don’t.  Discount points make for higher closing costs — especially on a refinance. See, on a purchase, you can sometimes get the seller to pay your discount points and closing costs. On a refinance, however, you’re on your own.

What Will Happen to Rates this Week?

This week, mortgage rates will be more volatile than usual. There isn’t much economic data on which to trade, and it’s a holiday-shortened week (again). Look for geopolitics and momentum to nudge markets forward, therefore — a potentially bad combination for today’s rate shoppers. There is very little room for mortgage rates to fall, but lots of room for them to rise.

If the stock market rallies to close 2011, mortgage rates will rise right along with it. So if you’ve been shopping for a mortgage – waiting for rates to fall – this may be a good time to lock that rate.

Click here for today’s mortgage rates.