The Federal Reserve's attempt to stabilize the housing market set off a chain reaction across the U.S. on Tuesday, dropping interest rates and quickly spurring a burst of refinancing activity by borrowers eager to lower their mortgage costs.

Some brokers said it was the most activity they've seen in at least one year, although there was no way to determine the volume of refinancing.

At Bank of America Corp., call volume was roughly twice what was expected at call centers and via the Internet, said Matt Vernon, national sales executive. "It's the folks who have been sitting on the sideline. They're jumping in with this news."

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Maria Arellano, center, joins a Tuesday rally in Sacramento, Calif., asking state lawmakers to stop home foreclosures and help modify home mortgage loans to make them more affordable.

Rates on 30-year fixed-rate mortgages dropped by roughly half a percentage point to about 5.5%, for borrowers with good credit scores and substantial equity in their homes, say mortgage brokers and lenders.

While the initial flurry of calls came from people seeking to refinance, economists predicted lower rates also will spur some home buying among bargain-seekers. The surge in refinancing will help the overall economy by putting more cash in consumers' pockets and reducing the pressure on some borrowers struggling to make payments.

"This is a win-win," said Susan Wachter, a professor of real estate at the University of Pennsylvania's Wharton School. "It will directly increase demand for housing and help with the downward spiral in home prices."

The positive response to the Fed action came amid grim news in the housing market. Home prices continued to fall as the economic downturn deepened in September, according data released Tuesday by S&P/Case-Shiller. For the third quarter, the S&P/Case-Shiller home price index posted a 16.6% decline from a year earlier, worse than the 15.1% drop recorded in the second quarter.

The government's latest plans won't fix all the problems bedeviling the housing and credit markets. And it's not clear whether the most recent initiative will keep mortgage interest rates down over the long run.

Mortgage rates had dipped briefly in past weeks following previous government actions, including the takeover of Fannie Mae and Freddie Mac. But then rates creeped upward.

Tuesday's lower rates will for now only benefit borrowers who have the cash and credit rating to qualify for mortgages under current lending standards. The Fed's actions won't make mortgages any easier to get for homeowners or buyers who haven't been able to qualify in recent weeks.

Lower rates also won't help the roughly 11.8 million borrowers who are unable to refinance because they owe more than their home is worth, said Mark Zandi, chief economist of Moody's Economy.com

"I don't think it changes any of the underlying fundamentals to the mortgage-origination process," said Mr. Vernon, of Bank of America. "What it does do is help those who have the ability to refinance, because they will get a lower rate and will have some increased cash flow, if they can get through the process."

Still, the government's latest action was expected to be welcomed by homeowners and potential homebuyers. "The biggest group of people that will benefit from this is that John Q. Citizen who was the responsible consumer in the first place -- the person who is the prime borrower who is starting to crack under the pressure of this bad economy," said Jeff Lazerson, a mortgage broker in Laguna Hills, Calif.

Some borrowers moved quickly to take advantage of the lower rates. Michael Menatian, president of Sanborn Mortgage Corp. in West Hartford, Conn., said his mortgage bank arranged for about 15 refinances of mortgages Tuesday as people rushed to lock in lower rates.

But he said about half-dozen other interested customers couldn't refinance because they had relatively low credit scores and too little equity in their homes. To get a rate of 5.5% Tuesday, he said, a customer would need a credit score of at least 720, about average, and home equity of 20%.

Chris Freemott, president of All American Mortgage in Naperville, Ill., said his firm locked in $4.5 million in deals on Tuesday. "It's easily been one year since we've seen that volume," he said.

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Among those benefiting from lower rates was James Ramsey of Aurora, IL., whose mortgage rate, currently 5.625%, was slated to increase by as much as a percentage point in January. On Tuesday, Mr. Ramsey locked in a 5.5% rate on his $180,000 mortgage. The refinance "is going to let me pay off a couple of credit cards really quick," he said.

The government's action was also greeted with relief by Scott Davis, a telecommunications project manager for the city of Phoenix, and his wife, Denise, a school teacher. On Tuesday, the couple locked in a refinance that will lower their mortgage rate to 5.375% from $6.75%, said Steve Walsh, their mortgage broker.

The Davises, who bought their home in July, needed help. They haven't been able to sell their old house yet and so are renting it out, but for less than their mortgage payments. All told, housing costs are eating up nearly half of their after-tax income, Mr. Davis says. The couple has stopped eating out and putting money into retirement accounts; they have also taken on second jobs to keep afloat.

Mortgage rates declined faster than yields on 10-year Treasury notes, which were quoted late Tuesday at 3.094%, down one-quarter of a percentage point from 3.342% on Monday. Mortgage rates tend to move in line with rates on 10-year Treasurys, but the gap between the two has widened recently.

That gap narrowed on Tuesday, which helped drive mortgage rates lower. The spread between rates on 30-year fixed-rate mortgages and 10-year Treasurys narrowed to 1.70 percentage points, compared with as much as 2.35 percentage points last week, said Credit Suisse Group mortgage strategist Mahesh Swaminathan.

Before credit markets seized up, the gap between the two averaged 1.23 percentage points, he said.

"Clearly, this is a major announcement," said Mr. Swaminathan, who expects mortgage rates to fall to as low as 5% over time. "It brings supply and demand into balance."

About $6 trillion of home mortgages were originated in 2005, 2006 and 2007, and interest rates on most of the fixed-rate loans in that period were 6% or more.

The $500 billion of Fannie, Freddie and Ginnie mortgage securities the Fed plans to buy accounts for a bit more than 10% of such securities outstanding, said Arthur Frank, head of mortgage-securities research at Deutsche Bank in New York.

Write to Ruth Simon at ruth.simon@wsj.com and James R. Hagerty at bob.hagerty@wsj.com

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