The Abbotsford home in Sydney's inner west was engulfed by flames about 4am on Tuesday.
First responders found the property well alight upon arrival.
An 88-year-old woman was trapped on the balcony, forcing officers and another occupant to rescue her with a ladder.
She and three other occupants - two men, 44 and 65, and the older man's wife, 53 - were treated by paramedics for smoke inhalation.
They are now in a stable condition.
NSW Police have deemed the fire suspicious.
The occupants were not believed to be criminally linked, Superintendent Christine McDonald said.
"We are working very closely with the occupants of this house ... and we will work through that as the hours proceed throughout the day," she said.
A suspect was seen spreading a form of accelerant, she said.
"A neighbour so bravely confronted (a male suspect) while they were setting the house alight," Supt McDonald said.
"(The suspect) managed to get away from the scene, but that neighbour is currently assisting police with inquiries."
Officers could only describe their suspect as male and "wearing a balaclava".
They were also searching for a red Holden Astra the suspect was believed to have fled in.
Fire and Rescue Acting Superintendent Peter Murray said about 40 crews and 10 trucks were in attendance at the height of the incident.
The blaze at one point spread to an adjoining house, though authorities were able to contain it within the building.
Firefighters were still working to fully extinguish the fire as of 7.45am, with police investigators ready to take on the scene later in the day.
The suspect is believed to have headed along Great North Road in Abbotsford and Lyons Road in Russell Lee after 4am.
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