WASHINGTON, June 21 (Reuters) - U.S. existing home sales fell for a third straight month in May as record high prices and a resurgence in mortgage rates sidelined potential buyers from the market.

Home sales dropped 0.7% last month to a seasonally adjusted annual rate of 4.11 million units, the National Association of Realtors said on Friday. Economists polled by Reuters had forecast home resales sliding to a rate of 4.10 million units.

Home resales, which account for a large portion of U.S. housing sales, decreased 2.8% year-on-year in May.

They added to a sharp drop in housing starts and building permits last month in suggesting that a re-acceleration in mortgage rates from April through May had sapped momentum from the housing market recovery. Residential investment scored double-digit growth in the first quarter.

The average rate on the popular 30-year fixed mortgage raced to a six-month high of 7.22% in early May before retreating to just below 7.0% by the end of the month, data from mortgage finance agency Freddie Mac showed.

Sales dropped 1.6% in the densely populated South. They were unchanged in the Midwest, which is considered the most affordable region, as well as in the Northeast and West.

Housing inventory increased 6.7% to 1.28 million units last month. Supply jumped 18.5% from one year ago. Entry-level homes remain scarce.

At May's sales pace, it would take 3.7 months to exhaust the current inventory of existing homes, up from 3.1 months a year ago. A four-to-seven-month supply is viewed as a healthy balance between supply and demand.

Despite the improvement in supply, the median existing home price surged 5.8% from a year earlier to an all-time high of $419,300. Home prices increased in all four regions.

"Eventually, more inventory will help boost home sales and tame home price gains in the upcoming months," said Lawrence Yun, the NAR's chief economist. "Increased housing supply spells good news for consumers who want to see more properties before making purchasing decisions."

Properties typically stayed on the market for 24 days in May, up from 18 days a year ago. First-time buyers accounted for a 31% of sales, compared to 28% a year ago. That share is well below the 40% that economists and realtors say is needed for a robust housing market.

All-cash sales made up 28% of transactions in May, up from 25% a year ago. Distressed sales, including foreclosures, represented only 2% of transactions, unchanged from last year. (Reporting by Lucia Mutikani; Editing by Andrea Ricci)