First-time buyers are having to save more for a deposit
Action is needed from the Bank of England otherwise the mortgage market will face "ongoing problems", says the Council of Mortgage Lenders (CML).
CML director general Michael Coogan said the Bank must improve levels of liquidity as strong demand for mortgages could not be met by lenders.
His comments came as the CML reported gross mortgage lending was £24bn in February, a 7% fall from January.
The drop had been predicted as the housing market has slowed.
"We have entered a substantially slower phase in the housing market and there will be ongoing problems in the mortgage funding markets unless the Bank of England makes new, broader based attempts to improve levels of liquidity in the UK," said Mr Coogan.
"Demand for mortgages remains strong but cannot be fully met from existing funding."
He said this had led to many lenders, facing the credit crunch, cutting the range of mortgages on offer, increasing their mortgage prices and, in some cases, reducing their lending capacity.
He predicted that mortgage offers would be chopped and changed in the coming weeks.
"As credit conditions change markedly from day to day, lenders will continue to rapidly adapt their products and pricing to match. This is a vital response to the uncertain conditions," he said.
The monthly CML figures showed that gross lending stood at £24bn in February, down 7% from £25.9bn in January, and 6% lower than the £25.6bn of February 2007.
Gross mortgage lending had risen in January, at which point the CML said it was expecting lower lending volumes in the coming months, driven by remortgaging and subdued house buying activity.
Slowing housing market
The Bank of England's Monetary Policy Committee (MPC) held interest rates in March after a cut from 5.5% to 5.25% in February.
Analysts suggest a further cut could come in April.
House price surveys have all suggested a slowing housing market.
According to a monthly survey from the Halifax, prices across the UK fell by 0.3% in February, taking the annual rate of inflation down from 4.5% to 4.2%.
The Nationwide suggested the slowdown was quicker, when it registered its fourth monthly price fall in a row and said prices in the three months to February had been 1% lower than in the previous three.
The Royal Institution of Chartered Surveyors said the number of UK surveyors reporting house price falls in February was close to the historic level of June 1990.
Giving evidence to the influential Treasury Select Committee on Wednesday, Chancellor Alistair Darling said that the UK housing market was in a much stronger position than in the US.
In the US, sub-prime borrowers - those with poor credit ratings who have been unable to keep up with mortgage repayments - have been at the heart of the turbulence in the economy because banks around the world had invested in their loans during the housing boom.
During his grilling by MPs, Mr Darling argued that these problems were far less prevalent in the UK.
Housing supply had exceeded demand in the US which led to plummeting house prices, a situation not seen in the UK, he said.
He added that there was a stronger regulatory regime for mortgage sales in the UK which meant default rates were low.