WASHINGTON (Reuters) - U.S. housing starts rose but below market expectations and building permits fell in March, pointing to underlying weakness in the housing market that could persist despite improving weather.

The Commerce Department said on Wednesday groundbreaking increased 2.8 percent to a seasonally adjusted annual rate of 946,000. February's starts were revised to show a 1.9 percent rise rather than the previously reported 0.2 percent fall.

Economists polled by Reuters had expected starts to rise to a 973,000-unit rate last month.

"Given the weather, housing is still disappointing," said Scott Brown, chief economist at Raymond James in St. Petersburg, Florida.

Compared to March last year, starts dropped 5.9 percent, the biggest decline since April 2011.

While a brutally cold winter weighed on home building in December and January, activity has also been hampered by shortages of building lots and skilled labor as well as rising prices for materials.

A report on Tuesday showed homebuilders in April were still downbeat about the sector's near-term prospects. The housing market is under strain from higher mortgage rates and elevated house prices that are sidelining potential buyers.

"Mortgage rates are higher than where they were a year ago and you have sluggish wage growth so a lot of the low-end buyers are being priced out," Brown said.

But there is a ray of hope for a pick-up. In another report on Wednesday, the Mortgage Bankers Association said applications for loans to buy houses rose last week.

The MBA's builder application survey data also showed mortgage applications for new home purchases increased 15 percent in March compared to February. The data has not been adjusted for seasonal fluctuations.

Groundbreaking for single-family homes, the largest segment of the market, surged 6.0 percent to a 635,000-unit pace last month. Starts for the volatile multi-family homes segment fell 3.1 percent to a 311,000-unit rate.

That was the lowest level since last October.

Starts jumped 30.7 percent in the Northeast and 65.5 percent in the Midwest, but fell in both the South and West.

Permits to build homes fell 2.4 percent in March to a 990,000-unit pace. Permits for single-family homes rose 0.5 percent but fell 6.4 percent for the multi-family sector.

Florida