Over 3,000 Muslim protesters turned violent over derogatory remarks against Prophet Mohammed allegedly made by a young Christian, Sawan Masih, 28, three days earlier, police official Multan Khan said.
The exact number of houses in Joseph Colony, a Christian neighbourhood in Badami Bagh area, were not immediately known but police and rescue officials said they belonged to low to middle-class families from the minority community.
"Police arrested Masih, a sanitary worker, on Friday night while the incident actually happened on Wednesday evening," Khan told AFP.
He said that the arrest was made when Masih's barber friend Shahid Imran complained that he had made blasphemous remarks about Prophet Mohammed, adding that Christians had fled the area on Friday evening, fearing a backlash.
Protesters began to assemble in the area on Saturday morning and later set on fire houses and other items including furniture, crockery, auto rickshaws, bicycles and motorbikes belonging to local Christians.
"Thick clouds of smoke engulfed the small houses, mostly consisting of one or two rooms, and many of them looked like charred shells," said an AFP reporter at the scene.
Police said protesters burnt 25 houses but Dr Ahmad Raza, in-charge of local rescue operations, and the independent Human Rights Commission of Pakistan (HRCP) put the number at more than 100.
"At least 160 houses, 18 shops and two small churches were burnt by protesters," Raza, who was busy in rescue operations in the area, told AFP.
Expressing grief and anger at the attack, HRCP chairwoman Zohra Yusuf put the number of houses burnt during the protest at over 100.
Police baton-charged the protesters to disperse them from the neighbourhood. There was no loss of life reported during the violence but 20 policemen were slightly injured during clashes, officials said.
Private Pakistani TV channels showed footage of violence from the scene as many masked members of the mob damaged or burned down households.
Provincial law minister Rana Sanaullah said in Lahore that the government would not spare those involved in the attack.
"These people committed a serious crime... there was no moral, legal or religious ground to indulge in such an act," he told private Express News TV channel.
Yusuf criticised the provincial government in a statement and said "it totally failed in providing protection to a minority community under siege".
Shamaun Alfred Gill, a spokesman for the All Pakistan Minorities Alliance, also condemned the incident and demanded that the government provide security to Christians.
Blasphemy is an extremely sensitive issue in Pakistan, where 97 percent of the population are Muslims, and allegations of insulting Islam or the Prophet Mohammed can prompt violent outbursts of public anger, even when unproven.
The laws came under the international spotlight in August last year when 14-year-old Christian girl Rimsha Masih was held for three weeks in a high security prison for allegedly burning pages from the Koran.