NEW YORK - The lowest mortgage rates in 3 months had U.S. consumers clamoring for home loans last week even as the government said on Wednesday it expected millions more foreclosures.

The Treasury Department followed up with a report saying only 12 percent of U.S. homeowners eligible For loan modifications under the Obama administration's housing rescue plan have had their mortgages modified.

But aside from the mixed picture on housing, the Federal Reserve said the overall economic situation was improving in spite of weakness in the housing and labor markets, while Treasury Secretary Timothy Geithner added that the economy was starting to grow again.

The housing market has been showing signs of stabilization in recent months, with sales on the increase and home price declines moderating in many regions of the country. In fact, home prices in some areas have risen.

Mounting foreclosures could mean another leg down for home prices and perhaps send the sector into a vicious cycle, analysts say.

The Treasury said 360,165 people had their monthly payments reduced through August, up from 235,247 through July, but a senior Treasury official conceded much more must be done to soften the impact of a severe and prolonged housing crisis.

The recent crisis in the housing sector has devastated families and communities across the country and is at the center of our financial crisis and economic downturn, Michael Barr, assistant Treasury secretary for financial institutions, told a House of Representatives Financial Services subcommittee.

But the housing crisis is showing signs of easing. The Federal Reserve's Beige Book survey said most regions reported some improvement in hard-hit residential real estate markets.

And U.S. mortgage applications surged last week to their highest since late May as consumers sought to take advantage of the lowest interest rates in months, data from the Mortgage Bankers Association showed.

The MBA said rates on 30-year fixed-rate mortgages tumbled to a 3-month low, spurring a surge in demand for home refinancing loans. Applications to buy a home, a tentative early indicator of sales, also climbed, hitting their highest since early January.

Low mortgage rates, high affordability and the government's $8,000 tax credit -- part of the economic stimulus bill -- for first-time home buyers have helped pave the way for stabilization.

CAUTIOUSLY POSITIVE

The Fed report said half of Federal Reserve districts saw evidence the U.S. economy had improved by the end of August, although labor markets remained weak and retail sales were flat overall.

Most districts noted that the outlook for economic activity among their business contacts remained cautiously positive, the Fed said.

But it also said there was still downward pressure on housing prices, and that business people in some areas believed recently higher vehicle sales levels were likely not sustainable after the government's cash for clunkers incentive program lapses.

Geithner, however, said the government's efforts to help the financial sector were paying off and helping the overall economy.

The economy is now growing again. We've seen the cost of credit start to come down. Banks are repaying the investments the government had to make in them with a significant... return, he said during a speech at Syracuse University in New York.

We are going to keep at this until we fix it --- until we get it back on track, he added

(Additional Reporting by Glenn Somerville, David Lawder, Tim Ahmann, Lisa Lambert and Mark Felsenthal, Editing by Chizu Nomiyama)

Timothy geithner Foreclosures