* January's home sales decline reverses rise
* Median home prices, inventories slid last month
* Mortgage applications dropped last week
(Adds details, updates markets)
By Lucia Mutikani
WASHINGTON, Feb 25 (Reuters) - Sales of previously owned homes plunged in January, reversing the previous month's jump, and prices spiraled to a six-year low as the deepening recession and rising joblessness took their toll.
But a drop in the number of unsold homes offered some hope for the housing market, the epicenter of the worst financial crisis of the post-war period, which has led to a 14-month-old U.S. recession and a $787 billion government stimulus package.
"Certainly a disappointing number. This brings us down to a new cycle low and obviously is reflective of the challenges and headwinds facing consumers and potential home buyers," said Tim Quinlan, an analyst at Wachovia in Charlotte, North Carolina.
The pace of sales of existing-homes fell 5.3 percent to a 4.49 million-unit annual rate in January from December, the National Association of Realtors said.
U.S. stocks fell on the dour housing report but cut losses after Federal Reserve Chairman Ben Bernanke calmed market fears that some troubled big banks could be nationalized and appeared to suggest that domestic equities were cheap.
The Dow Jones industrial average <.DJI> ended down 80.05 points at 7,270.89. Government bond prices, which normally rally on weak economic data, were depressed by worries about the amount of debt the government will issue to rescue the economy.
HOME PRICES PLUNGE
The median national home price declined 14.8 percent from a year ago to $170,300, the lowest since March 2003, the association said, adding that roughly two in five home sales were "distress" transactions.
The collapse of the U.S. housing market and the resulting global credit crisis pushed the domestic economy into recession in December 2007.
Few buyers are willing to take advantage of the lowest home prices in several years as most households are experiencing sharp declines in wealth, compounded by rising unemployment and collapsing stock market prices.
"At some point, prices will drop so much that sales will start to pick up. So far, this has yet to happen despite the fact that housing is as affordable now as it has been in decades," said Patrick Newport, an economist at IHS Global Insight in Lexington, Massachusetts.
A separate report showed applications for mortgages fell last week as mortgage rates edged higher. The decline followed recent robust increases in applications after the government unveiled its strongest action yet to aid struggling homeowners.
The Mortgage Bankers Association's seasonally adjusted index of mortgage applications, which includes both purchase and refinance loans, fell 15.1 percent to 743.5 in the week ended Feb. 20 after surging 45.7 percent the prior week.
An easing in the glut of unsold existing homes offered a ray of hope that the housing market could find some stability later this year, crucial for a turnaround in the economy.
The inventory of existing homes for sale fell 2.7 percent to 3.60 million from the 3.70 million overstock reported in December, the NAR said.
Analysts are optimistic that the declining stock of unsold houses, a growing population and the government's $275 billion plan to stem the tide of foreclosures could lay the foundation for housing's recovery in the months ahead.
"The supply of unsold existing homes has started to shrink. The population is growing by 3 million per year and a basic element of life is shelter," said Tony Crescenzi, chief bond market strategist at Miller, Tabak & Co in New York.
However, sales fell faster than supply of unsold homes, and the 9.6 months it would take at the current pace to clear the market was up from December's 9.4 months.
The real estate group said it expects the recent federal stimulus package and other rescue measures to spur 900,000 home sales this year.
(Additional reporting by Patrick Rucker in Washington and Julie Haviv in New York; Editing by Kenneth Barry)