Nearby residents, passers-by and police jumped into the lake and tried to pull them from the submerged car.
The surviving child is described as being in a serious condition in the Royal Children's Hospital.
"The woman has been taken to hospital and is under police guard," police said.
She is in a stable condition in the Royal Melbourne Hospital.
Superintendent Stuart Bateson said it was too early to tell whether she was the mother of any of the four children.
"What we do know is that when the car left the road, passers-by and police members got some of the children out and did CPR," he told reporters at the scene.
"What we do know is that we have a very tragic set of circumstances here and it is going to be a very harrowing investigation."
Everyone there had been affected, he said.
"When you come to a scene like this, and my members in particular, who have been performing CPR for an extended period of time, are really feeling it."
Sara Omar, 17, was walking in the parkland near the lake's edge when the crash occurred.
"I didn't really see much because I was around the other side, but I heard a massive 'boom'," Ms Omar said.
She saw a man run into the lake to try to rescue the children.
"He broke the window of the back seat of the car and he tried to take the little kids out and he put them on the end of the lake," Ms Omar said.
"I saw the ambulance taking a little kid and I think they were resuscitating him."
One woman who lives opposite the lake saw firefighters pull one child from the vehicle.
"They couldn't get the car open," she told the Age newspaper.
"They were banging, trying to get the car open and trying to smash its windows."
Emergency workers tried CPR for a long time, she said.
"They looked very emotional, they were exhausted."
Last night, police and emergency workers had floodlit the area and placed a wide cordon around the vehicle.
Only the roof and upper portion of the windows were visible above the water line.
A Victoria Police spokeswoman said it would be pulled from water today.
- AAP
