Mortgage providers are now looking to attract the least risky business and deter those looking for high levels of deposit and those with a small amount of equity resulting in an increase.

Increasingly, lenders including Halifax, Lloyds TSB and Woolwich, are reportedly offering significantly better rates on mortgages with a LTV of 60%. Additionally, borrowers coming off cheap two-year fixed-rate deals with little or no equity in their properties have to contend with the dual effects of higher interest rates on mortgage deals and higher LTV requirements. As a result, analysts say there are likely to be further defaults on mortgage payments leading to repossessions in the near future.

After a spate of repricing earlier in the year the mortgage market calmed down in recent months, partly as a result of the relative stability of three-month Libor (interbank lending) rates. However, yesterday's alterations could prompt a fresh round of repricing across the rest of the market. Now the Banks have been strongly advised by Alistair Darling to stop taking advantage of borrowers by charging huge arrangement fees.

According to a report by the Financial Times, the chancellor dangled the threat of action by the City watchdog, the Financial Services Authority, in front of mortgage lenders to persuade them to reduce such fees, which apply not only to homebuyers but to others changing mortgage. His reaction came as crisis deepened over the housing downturn. Earlier, data from the British Bankers' Association indicated that mortgage approvals by banks fell last month at the fastest annual pace in a decade or more.

Mr Darling said: “We have met the Council of Mortgage Lenders to try to reach an agreement to ensure that people are treated fairly, but if that isn't happening I will ask the FSA to pursue the matter." Some lenders have been able to apply four-figure arrangement fees of up to £3,000 to allow borrowers access to more attractive deals. The chancellor rejected the idea of an upper limit but warned that people should be "treated fairly, especially people coming off fixed rates and going on to different rates.”

The CML pointed out that higher arrangement fees usually went hand in hand with low interest rate products and vice-versa and that consumers had a choice between the two. However, the Treasury hopes a review of the wholesale lending markets by Sir James Crosby, to be published this summer, may hold the key to unlocking the mortgage market.

But underlining the scale of the problem, the BBA said yesterday the number of loans approved for house purchase fell from a downwardly revised 34,752 in April to 27,968 per cent in May - 56.1% lower than a year earlier and easily the lowest level since the BBA's data series began in 1997. Bank of England data covering a broader range of lenders are likely to show an even bigger drop when figures for May are published.