The United Nations has called on Israel to end its programme of demolishing homes in East Jerusalem and tackle a mounting housing crisis for Palestinians in the city.

Dozens of Palestinian homes in East Jerusalem are demolished each year because they do not have planning permits. Critics say the demolitions are part of an effort to extend Israeli control as Jewish settlements continue to expand. The 21-page report from the UN office for the co-ordination of humanitarian affairs is the latest round in an intensifying campaign on the issue.

Although Israel's mayor of Jerusalem, Nir Barkat, has defended the planning policy as even-handed, the US secretary of state, Hillary Clinton, in March described demolitions as "unhelpful". An internal report for EU diplomats, released earlier and obtained by the Guardian, described them as illegal under international law and said they "fuel bitterness and extremism". Israel occupied East Jerusalem in the 1967 war and later unilaterally annexed it, a move not recognised by the international community.

The UN said that of the 70.5 sq km of East Jerusalem and the West Bank annexed by Israel, only 13% was zoned for Palestinian construction and this was mostly already built up. At the same time 35% had been expropriated for Israeli settlements, even though all settlements on occupied land are illegal under international law.

As a result Palestinians in East Jerusalem had found it increasingly difficult to obtain planning permits and many had built without them, risking fines and eventual demolition, the UN said. As many as 28% of all Palestinian homes in East Jerusalem were built in violation of Israeli planning rules.

"Throughout its occupation, Israel has significantly restricted Palestinian development in East Jerusalem," the UN report said. It said 673 Palestinian structures had been demolished in the east between 2000 and 2008. Last year alone 90 structures were demolished, leaving 400 Palestinians displaced, the highest number of demolitions for four years. Similar demolitions are carried out regularly by the Israeli military across the West Bank.

The UN said it was particularly concerned about areas facing mass demolition, including Bustan in Silwan, just south of the old city, where the threatened destruction of 90 houses would lead to the displacement of 1,000 Palestinians.

Families who lose their homes are faced with the choice of moving into crowded apartments with relatives or renting new homes. They face "significant hardships", including having their property destroyed and struggling with debts from fines and legal fees, the UN said.

A 2007 survey, quoted in the UN report, found that more than half of the displaced families took at least two years to find a new permanent home and often moved several times in the process. Children missed out on school and suffered emotional and behavioural problems for months, with poor academic records over the longer term.

The authorities in Jerusalem challenged the UN report and denied "the accusations and numbers throughout". Israel's Jerusalem municipality accepted there was a "planning crisis" but said it was "not just in eastern Jerusalem but throughout all of Jerusalem that affects Jews, Christians and Muslims alike". It said the mayor would present a new plan for the city.

"Recent events indicate that the Jerusalem municipality will maintain, and possibly accelerate, its policy on house demolition," the UN report said. "Israel should immediately freeze all pending demolition orders and undertake planning that will address the Palestinian housing crisis in East Jerusalem."

Last week, Barkat, who won election five months ago, rejected international criticism of demolitions and planning policy as "misinformation" and "Palestinian spin. There is no politics. It's just maintaining law and order in the city," he said. "The world is basing its evidence on the wrong facts.The world has to learn and I am sure people will change their minds."

Barkat said he wanted to improve the life of all the city's residents, Jewish and Arab, but that he was committed to maintaining a Jewish majority. Jews make up around two-thirds of the city's population.

The UN said nearly a third of East Jerusalem remained unplanned, meaning there could be no construction. Even in planned areas there were problems, including the number of small privately held plots, poor infrastructure and few resources.

Although the number of permit applications more than doubled between 2003 and 2007, the number of permits grants remained relatively flat, the UN said. There was a gap between housing needs and permitted construction of 1,100 housing units a year. "Due to the lack of proper urban planning, the under-investment in public infrastructure and the inequitable allocation of budgetary resources, East Jerusalem is overcrowded and the public services do not meet the needs of the Palestinian population," the report said.