OREANDA-NEWS. U.S. home prices will grow by 4.5% in 2016 and nominal prices will approach levels reached during the 2006 housing bubble, Fitch Ratings says. U.S. growth will outpace that of Canada, where we expect a 2.5% increase in home prices. However, unlike the U.S., Canada's national prices are overvalued by more than 20% compared to long-term economic fundamentals, leaving Canadian home prices exposed to more downside risk.

U.S. prices appear more sustainable than a decade ago. Since then, the country's population has increased by over 20 million people and total gross income is up by roughly 25% in nominal terms. When adjusted for inflation, U.S. home prices remain more than 20% below their 2006 peak levels. And new home construction in the U.S. is rebounding from its post-crisis lows but remains below long-term historical averages.

However, some regional U.S. markets are overvalued. California and Texas may experience a softening in their housing markets, though large downturns are unlikely. The fall in commodities prices could also put further downward pressure on Texas home prices. California's home price growth has eroded affordability, which has declined approximately 25% in the state since 2011.

Canada's low mortgage rates and steady employment continue to drive home prices, which increased by almost 6% in 2015. However, the sharp drop in oil prices, beginning in 2H14, has hit economic growth (Fitch expects GDP growth of 2% in 2016), and affordability remains a concern. High prices have caused borrowers to take on increasingly large debt burdens to purchase homes. Household indebtedness is at 165.5% of disposable income and is among the highest of Fitch-rated sovereigns, with credit growth accelerating since the Bank of Canada's January 2015 interest rate cut.

In 2016, Canadian affordability will continue to be pressured as prices rise, albeit modestly. Should Canadian interest rates rise in concert with U.S. policy tightening, wage growth will be insufficient to prevent the Canadian market from cooling. Yet, the lack of risky mortgage products and high average borrower equity should mute the impact of an increased debt burden on performance. We forecast Canadian arrears to remain stable at very low levels this year.

U.S. mortgage rates are expected to rise 25 bps to 50 bps by year end, which should not affect existing borrower performance in a mostly fixed-rate market but will encourage lenders to broaden loan eligibility requirements as refinance volumes dry up.