Banks and building societies have been warned that they may breach regulatory rules if they fail to pass on further cuts in the base rate to millions of borrowers with tracker mortgages.

Many tracker mortgages have "collars", which state that lenders will stop passing on interest rate reductions once the Bank of England base rate falls below a certain level.

The Financial Services Authority (FSA) warned today that these restrictions may be unenforceable if they were not clearly explained to customers when they took out the loan.

Speaking at the Council of Mortgage Lenders’ annual conference, Jon Pain, the FSA’s retail markets manager, said: “Whilst tracker interest floors can be a legitimate term of a mortgage, this can only be if it is clear and unambiguous to the consumer and is consistently and prominently spelt out in the initial Key Facts Illustration and offer document throughout the sales process.

“If it is not, you run the real risk of both breaching our disclosure requirements and having an unfair contract term you can’t enforce.”

Around 4.2 million homeowners with tracker deals are looking forward to another sizeable reduction in their monthly repayments if, as expected, the Bank of England cuts rates on Thursday. Some economists are predicting that the base rate will drop to 2 per cent saving someone with a £150,000 tracker loan nearly £80 a month.

However, a growing number of lenders have been imposing collars, which give them freedom not to pass on reductions once the base rate has fallen to a certain point.

Halifax, Britain's biggest lender, will not reduce trackers if the base rate falls below 3 per cent. Therefore, a deal pegged at one point above base would remain at 4 per cent even if the Bank of England were to cut the base rate to 2 per cent. Abbey has a similar rule for some older trackers, as do Yorkshire, Skipton, Norwich and Peterborough, and Scarborough building societies. Nationwide has a 2.75 per cent collar on its trackers.

Mr Pain also repeated the FSA's recent demand that lenders treat customers who fall behind with mortgage payments fairly.

He said: “With falling house prices we have seen some lenders tempted to take swift action on arrears and repossessions to minimise losses. I have a clear message here and that is, in such a challenging operating environment, it is particularly important that you focus on the fair treatment of your customers when they go into arrears.”

The FSA has recently written to the chief executives of all mortgage lenders calling on them to ensure that they are treating customers in financial difficulty fairly in practice.The move followed a review by the FSA which found that lenders needed to make improvements in this area, with specialist lenders having the most work to do.