07/14/2014 04:30 EDT | Updated 07/14/2014 04:59 EDT

Canada's Housing Market Overvalued By 20 Per Cent, Fitch Warns

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Ottawa may need to step in again to cool an overheated housing market that is showing no signs of slowing, according to a global credit rating agency.

Fitch Ratings said Monday that Canadian home prices are overvalued by 20 per cent based on historical drivers of home price growth.

If the market doesn’t start to fizzle on its own soon, it added, the federal government might have to act again to prevent a crash after already making four mortgage tightening moves in four years.

“The long-term impacts remain unclear, and policy makers may be required to take additional steps over the short term to engineer a soft landing.”

The ratings agency cites historically low interest rates since the recession as well as tight supply of available homes in metropolitan areas as factors propping up the market.

Ultra-low interest rates have made consumer borrowing cheap for nearly six years, which has also contributed to dangerously high levels of household debt-to-income ratios, which currently sit an an average of 163 per cent. That means Canadians owe $1.63 for every dollar earned.

“We believe high household debt relative to disposable income has made the market more susceptible to market stresses like unemployment or interest rate increases,” the rating agency said.

Fitch also warned that interest rates are more likely to rise than fall further, and the hikes could put pressure on those who took on more debt than they’d be able to afford.

The Bank of Canada has singled out high rates of household debt as one of the biggest threats to the economy. When interest rates inevitably rise, carrying costs for mortgages and other forms of debt could become unaffordable for some Canadians and leave them underwater on their mortgages.

Ottawa has already moved several times in the past few years to rein in lending to those who could be most vulnerable — including cutting the maximum mortgage length — but prices continue to rise. Prices rose 4.4 per cent in June compared to the same month in 2013, according to the most recent Tearnet-National Bank home price index.

Capital Markets economist David Madani, who has predicted a housing crash is on the way, said a recent drop in mortgage costs could propel sales in the short term and delay a weakening in prices.

“But we still believe that the housing market is headed for a major correction over the longer term,” he added.

Experts have long predicted a slowdown in the housing market that has yet to occur, with even the seemingly overheated condo market showing resilience. However, many compare the market to a balloon rather than a bubble, that will slowly deflate rather than burst.

And some have warned that any further moves to curb borrowing could go overboard and cause unintended consequences if a slowdown does begin.

But international watchers, including the OECD and the Economist, have also warned signs point to overvaluation in Canada’s housing market. The OECD recently called on the federal government to pull back on government-insured mortgages to protect taxpayers from a potential downturn.

"Almost 40 per cent of the country's population lives in a city where house prices are seriously or severely unaffordable," the OECD said in a report from June.

"A shock to even one segment could have spillover effects to the broader economy if banks respond by tightening credit significantly or if negative wealth effects depress consumption."

Even the country’s mortgage lenders feel the market is at risk of entering bubble territory, according to a survey released earlier this month.

The average home price rose to $416,584 in June, up 7.1 per cent from the same month a year ago, according to the latest figures from the Canadian Real Estate Association. Data from July is expected Tuesday.

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