However, July's performance was better than analysts expected. Wall Street economists forecast that housing starts would drop to a pace of 950,000.
Still, the latest housing figures continue to show a badly battered housing market, one of the biggest problems plaguing the already shaky national economy.
The report showed that construction of single-family homes in July fell by 2.9 percent from the previous month to a pace of 641,000. That was the lowest since January 1991, when the economy also was in distress.
New home construction last month was down a sharp 39.2 percent compared with July 2007, illustrating how much ground the housing market has lost in the past year.
Construction of apartments and other multifamily dwellings also fell sharply in July, after a large jump in the previous month due to a change in New York City's building codes. That change, which went into effect July 1, gave a rare lift to overall housing construction in June.
Housing permits in July fell to a rate of 937,000, a 17.7 percent drop from June, but still above analysts' expectations of 925,000. Permits are considered a reliable sign of future activity.
Homebuilders are hoping the housing rescue package approved by Congress last month will boost the dismal real estate sector. The law includes a temporary $7,500 tax credit for first-time homebuyers that essentially works out to a 15-year, interest-free loan.
The National Association of Home Builders/Wells Fargo housing market index, released Monday, remained at a record low of 16 in August for the second consecutive month. Readings below 50 indicate negative sentiment about the market.
But one measure of longer-term sentiment improved slightly: a measure of builders' sales expectations in six months rose two points to 25.
Still, homebuilder Toll Brothers Inc. reported dismal quarterly results last week when its revenue fell 34 percent and its order backlog plunged 52 percent.
Shares of several homebuilders, including Toll Brothers, D.R. Horton Inc. and Pulte Homes Inc., dropped Monday, partly due to renewed fears about the financial health of mortgage giants Fannie Mae and Freddie Mac.