Jones, who had lost to Hou in the final of last year's world championships, rode a wave of support from the home crowd to bully her way past the Chinese fighter, running out a 6-4 winner to earn Britain's 25th gold of the Games.
The 19-year-old from north Wales grabbed British and Welsh flags from the crowd and raced around in a lap of honour as the 8,000 fans in the ExCel arena roared her on.
Jones, who won gold at the 2010 Youth Olympics in Singapore after the people of her hometown Flint helped finance her trip for the qualifiers, said winning gold was something special.
"It feels crazy. It's amazing and the crowd's amazing," she said. "To be the first (British) athlete to win Olympic (taekwondo) gold is amazing."
Jones also paid tribute to her team mate Sarah Stevenson, who will compete in the welterweight division on Friday, and said she owed everything to her coach Paul Green.
"The coach is a legend. Without him I wouldn't be where I am today."
Green praised his charge's work ethic and said there was more to come.
"The work this girl's been putting in over the last six months is ridiculous. She's been getting up at six, tears every day, but she's a fighter and she works hard.
"She's still got improvements to make in the game but the future's bright for her. She delivers under pressure."
Jones was in fearsome form in the opening two rounds, overwhelming her opponents 15-1 and 13-3 and, despite facing a serious step up in class against world number one Tseng Li-cheng in the semi-final Jones simply forced her way into the final.
The first two rounds of the gold medal match were cagey, but heading into the third Jones had sneaked a 2-0 lead.
With Hou desperate to get back on level terms, Jones bided her time and landed kicks to her opponent's midsection to seal the gold medal.
"Before I came out I thought I'm not letting her beat me here in front of the home crowd," said Jones.
China's Hou was not too disappointed to miss out on gold and conceded that Jones had been the stronger fighter.
"This is my first Olympic Games, so I'm 90 per cent satisfied with the silver medal," said Huo.
"I've already been world champion twice but at the Olympic Games there's more pressure."
Marlene Harnois of France and Taiwan's Tseng won the bronze medals after the repechage competition.
Another Brit Martin Stamper was unable to claim another taekwondo medal beforehand, losing the men's bronze medal match 5-3 to Afghan Rohullah Nikpah.
"The Olympics are always special, I'm happy. I'll bring this medal back home," said Nikpai.
"I think that right now everyone in Afghanistan must be dancing."
Earlier, Stamper was beaten by Servet Tazegul, the Turk going to win the men's featherweight gold medal with victory over Iran's Mohammad Baghrei Motamed in the final.
Tazegul, the world number one and Beijing bronze medallist, won 6-5 and was the class act of the -68kg category.
His aggression and speed was too much for Motamed, who also lost to Tazegul in the final of last year's world championships in South Korea.
Tazegul dedicated the gold medal to his mother, who died earlier this year.
"I lost my mother two months ago. I really wanted to get the gold for her," he said. "But it was a hard time, I did not train much plus I had the injury."